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INFALTION UNEPLOYMENT REALTIONSHIP

In the short run, the unemployment rate (U) and aggregate output (income) (Y) are
negatively related.

As depicted by this short run AS curve, the relationship between Y and the price level (P)
is positive.

The relationship between U and P is negative. As U declines in response to the


economy moving closer and closer to capacity output, the overall price level rises
more and more.
INFLATION RATE

The inflation rate is the percentage change in the price level.

PHILIPS CURVE

Named after British economist WILLIAM PHILLIPS (1914-1975), Phillips curve charts
the significant relationship between the percentage change inflation rate and rate of
unemployment.

Its main implication is that low inflation and low unemployment are incompatible, and so
governments have to choose the best combination of both.

The Phillips Curve shows the relationship between the inflation rate and the
unemployment rate.

There is a trade-off between inflation and unemployment. To lower the inflation rate,
we must accept a higher unemployment rate.

The Phillips Curve: A Historical Perspective


In the 1960s and early 1970s, inflation appeared to respond in a fairly predictable way
to changes in the unemployment rate in the case of the economy of UK. Philips curve
relationship was first established with the data of the economy of UK.

BREAK DOWN OF PHILIPS RELATIONSHIP

But in the 1970s and 1980s, the Phillips Curve broke down.
The points on this figure show no particular relationship between inflation and
unemployment.

EXPECTTION AND PHILIPS CURVE

Inflationary expectations shift the Phillips curve to the right. This means that high
inflation rate and high unemployment will exist together.

This happens because as workers expect price rise they put pressure on employers to
increase wages this decreases the demand for workers and unemployment rises.

Inflationary expectations were stable in the 1950s and 1960s, but increased in the 1970s.