Page 210 - DECO402_Macro Economics

Unit-23: Phillips Curve Analysis

Second reason influencing this inverse relation between money wage rates and unemployment is Notes
nature of trade activities. In the period of increasing trade activities when unemployment will be
falling along with increasing demand of labour, then masters will increase the wages. As opposed
to this, during the period of reducing trade activities when demand for labour will be falling and
unemployment increasing then masters do not get ready to increase wages. Instead they reduce wages.
But labourers and organisations dot not agree to accept cut in wages in these periods. As a result,
masters are compelled to fire the labours from the job. In this manner when labour market goes under
recession, then it will bring little cut in wages and more increase in unemployment.
Phillips on the basis of above mentioned reasoning took out the inference that on showing the relation
between rate of unemployment and changes in money wages in a figure, it will be non-linear. Such
curve is known as Phillips curve.
In figure 23.1 curve PC is a Phillips curve.
It tells the relation of percentage change in
money-wage rate (W) on the vertical axis and
rate of unemployment (V) on the horizontal
axis. This curve is convex to the central point
which shows that when rate of employment
falls the percentage change in money wages
increases. In the figure when money wage
rate is 2% then unemployment rate is 3%.
But when wage rate increases to 4%, then
unemployment rate decreases to 2%. In
this manner, trade-off takes place between
rate of change in money wages and rate of
unemployment. It means that when wage
rate is high then unemployment rate reduces
and vice versa.
Figure 23.1
Original Phillips curve was an investigated
statistical relation which Lipsey had described theoretically in form of result of behaviour of labour
market in imbalance through more demand.
Many economists have extended the Phillips analysis till the situation of trade-off between rate of
unemployment and rate of change in price level or inflation rate. They take this assumption that
when wages will increase faster than labour productivity, then prices will change. If rate of increase of
monetary wages is more than the rate of increase of labour productivity, then price will rise and vice
versa. But if labour productivity rate increases equal to money wage rates then prices will not rise.
This trade-off between inflation rate and unemployment rate has been described in figure 23.2. Here
inflation rate (p) has been taking with rate of change in wages (w). Assume that labour productivity
increases at the rate of 2% and if money wages also increase at the rate of 2%, then prices-level will
remain stable. In this manner, on curve PC point B, percentage change in money wages (M) and
unemployment rate of 3 percent (N) are equal at zero (0) percent inflation rate (p) at vertical axis. Now
assume that economy is working on point B. If now entire demand is increased then it will reduce
unemployment rate at OT (2%) and increases wage rate up to OS (4%) per year. If labour productivity
keeps increasing at 2% per year then price level will also on OS in the figure at the rate of 2%. Now
economy works at point C. In change of economy from point B to point C, unemployment reduces to
point T (2%). Like this, when increase in money wage rate will be more than labour productivity, it
will bring inflation. For stopping inflation, for keeping wage rise at the level of labour productivity
(OM), ON rate of unemployment will have to be tolerated.

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