15 The Phillips Curve and Aggregate Supply - The Phillips...

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15-1The Phillips Curve and Aggregate Supply
15-2Payroll Employment
15-3Payroll Employment
15-4Unemployment Rate
15-5Employment-to-Population Ratio
15-6Average Hourly Earnings
15-7Today’s Agenda1.The Phillips Curve2.The Aggregate Supply Curve
15-8The Phillips Curve
15-9The Phillips CurveThe Phillips curveis the inverserelationship between:1.Inflation, π, and2.The unemployment rate, U.
15-10The Phillips Curve
15-11The Phillips Curve
15-12The Phillips CurveThe Phillips curveis downward slopingbecause:1.When unemployment is unusually low, the demand for labor will exceed the supply of labor and wages will rise more quickly.2.Because wages are a major input into total costs, more rapidly rising wages leads to higher inflation.
15-13The Phillips CurveThe Phillips curve was originally based on an inverserelationshipbetween:1.Nominal wages, W, and 2.Unemployment,U.
15-14The Phillips CurveThe firstmajor flaw in the original Phillips curve analysis was that it failed to distinguish between nominal wages,W,and real wages,w.1.Labor market incentives for working and hiring are determined by real, not nominal, wages.2.If workers and businesses expect inflation to increase, they will also adjust nominal wages higher so that the real wage does not fall.
15-15The Phillips CurveThe secondmajor flaw in the original Phillips curve analysis was that it failed to recognize that in the long-run, when all wages and prices are completely flexible, unemployment would be at the natural rate of unemployment, UN .This is the unemployment rate consistent with the economy’s long-run steady state.
15-16The Phillips CurveIncorporating these two changes, the Phillips Curve becomes the expectations-augmented Phillips curve, given by:i.e., actual inflation is:1.Positivelyrelated to expected inflation, and2.Inverselyrelated to the unemployment gap, U - UN.π = πeω( U – UN)πe,
15-17The Phillips CurveThe expectations-augmented Phillips curve:implies that:1.when U = UN 2.then π = πeω( U – UN)π = πe
15-18The Phillips CurveBecause in the long-run, U = UN:1.There is no long-runtrade-offbetween unemployment and inflation.

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