Page 211 - DECO402_Macro Economics

Macroeconomic Theory

Notes

Notes When demand for labour is less and unemployment more, then, labours do not
agree to render their services at less than the current rates.

Shape of curve PC further suggests this also that when rate of unemployment is less than 5½ % (i.e.
towards the left side of point A) then demand for labour is more than the supply for labour and by
this money wage rates will increase. At the other side when unemployment rate is more than 5½ %
(towards the right side of point A) then supply of labour is more than the demand which reduces
wage rates. Meaning that at the OA rate of unemployment which is 5½% per year, wage rates will
be stable.
It must be remembered that PC is conventional or original downward sloping Phillips curve which
represents a stable and inverse relation between rate of unemployment and rate of change of
wages.

Self Assessment

Fill in the blanks:
1. Phillips curve investigates relation between rate of unemployment and rate of change
in....................
2. When unemployment is too much then rate of increase in money wages is .................

23.2 Friedman’s View: The Longrun Phillips Curve

Economists have criticised Phillips curve and have also amended at many places. They believe
that Phillips curve is related to short term and does not remain stable. It shifts along with changes
in expectations for inflation. In long term, trade- off does not take place between inflation and
employment. These views have been established by Friedman and Phelps and their theory is famous
by the name of Accelerationist or Adaptive Expectations Hypothesis.
According to Friedman for describing trade-off between unemployment and inflation there is no need
to assume a stable downward right sided Phillips curve. In reality, this relation is a short term event.
But many variables are there which of Phillips curve moves in long term. The most important variable
of these are the expected rate of inflation. As long as there is difference between the expected rate and
actual rate of inflation till then there will be right side downward sloping Phillips curve. But when
this difference ends in long term, Phillips curve becomes vertical. For describing it Friedman presents
the concept of ‘natural rate of unemployment’. It is that rate of unemployment at which economy
often stay at because of its structural errors. It is that unemployment rate below which inflation rate
increases and above which inflation rate decreases. At this rate, tendency of inflation rate is of neither
increasing nor decreasing. In this manner, Natural rate of unemployment may be defined as such rate
of unemployment at which actual rate of inflation and expected rate of inflation are equal. Hence it is
a balance rate of inflation towards which economy goes in long term. In long term, at natural rate of
unemployment Phillips curve is a vertical line. This natural or balanced rate of unemployment is not
decided for always. But it is determined by goods markets inside the economy and many structural
attributes of the labour. These may be minimum ages rule, insufficient employment information,
and shortcomings in man power training, cost of labour velocity or other market incompletes. But
for which reasons, Phillips curve moves in long term, it is the expected rate of inflation. Its relation

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