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Unit-23: Phillips Curve Analysis

may be influenced. But economists do not Notes
agree with Friedman. Their opinion is that by
the medium of labour market policies natural
rate of unemployment may be reduced as a
result of which labour market becomes more
able. Hence by shifting the long term Phillips
curve to the left natural rate of unemployment
may be reduced. But policy implications of
Phillips curves are not as easy as they seem
to be. When officers’ start deciding about
such inflation rates which match with some
specific rate of unemployment, then they have
to face obstacles. In this way problem of trade
off between inflation and unemployment is
problem of selecting under obstacles. It has
been shown in figure 23.5. Obstacle is to express
selection between given Phillips curve PC
and indifference curves I , I , I , I , I , I , I’, I’. Figure 23.5
2
3
3
1
1
2
Indifference curve is concave to point of origin
because if officers want reduce unemployment then they will have to increase inflation and if they want
to increase unemployment then inflation will have to be decreased. That is why this curve expresses
negative usage. But in comparison to I I curve, I I curve expresses much higher welfare- level of
2 2
1 1
public welfare. Its reason is this that in comparison to higher curve, any point on the lower curve
expresses lower rate of unemployment and inflation. Best point of trade-off is E where indifference
curves I I touches Phillips curve PC where there is trade-off between OA rate of inflation and OB rate
2 2
of unemployment. But if officers adopt such monetary and fiscal policies by which they wish to reduce
inflation and increase unemployment, then indifference curve will become I’I’. This I’I’ curve touches
Phillips curve at point F and trade-off take place between OC inflation and OD unemployment.
Some economists have suggested that there is a loop around Phillips curve based on observation
values of inflation and unemployment. It has been shown in figure 23.6 . In the first step of expansion
in trade cycle, in unemployment-inflation loop decreasing inflation and increasing production is
found. Its reason is that as a result of expansive monetary or fiscal policy demand pull inflation
occurs. In this step of the cycle general relation between inflation and unemployment suggested by
Phillips curve is maintained. It has been shown
from below the Phillips curve by movement of
arrows, when rate of unemployment falls and
rate of inflation increases. If increase of total
demand continues and inflationary pressures
gain advantage, then dotted loop crosses the
Phillips curve at point A. In adopting expensive
monetary and fiscal policy, total demand will
fall. But expectation of increase in prices will
bring increase in wages and previous rate of
inflation will only be maintained. This is why
unemployment will increase and prices will not
decrease. This fact is expressed by the upper
part of loop situated to the right of Phillips
curve. But when more demand gets controlled
and production increases then along with rate
of unemployment falling, inflation rate starts
Figure 23.6

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