Chapter11 - Chapter 11 The Phillips Curve One recurring...

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© Sanjay K. Chugh 125 Spring 2008 Chapter 11 The Phillips Curve One recurring stylized feature of short-run macroeconomics is a negative relationship between the inflation rate and the unemployment rate. Despite its seeming regularity in the data, there has been and remains considerable debate in the economics profession about how best to model such an effect at a theoretical level – indeed an important branch of the profession simply dismisses the relationship as an unimportant one and thus not even worthy of serious theoretical modeling. But this inflation-unemployment tradeoff seems to still drive much policy discussion, and as such we will adopt the view that it is a potentially important feature of macroeconomics. In this section we will briefly explore how we can modify our existing theoretical model of the macroeconomy to explain the inflation-unemployment tradeoff. Nominal Wage Rigidity and the Short-Run Phillips Curve Consider the view of the labor market we have developed thus far, depicted in Figure 48, in which a downward-sloping labor demand function interacts with a backward-bending labor supply function to determine the equilibrium wage in the economy. In such a labor market, where labor supply always equals labor demand, unemployment is by definition zero. Recall that an “unemployed person” is one who is actively looking for employment who has not yet found employment. At the equilibrium wage * W in Figure 48, no individual wishes to work more hours than he already is. Technically, this is zero unemployment – however, we will appeal to our notion from earlier that there is a “natural” rate of unemployment in the economy, because, for example, of individuals optimally choosing to leave one job to look for another. With the notion of a natural rate of unemployment in the background of our model, then, equilibrium in the labor market implies that the unemployment rate equals the natural rate of unemployment and hence cyclical unemployment is zero. The crucial point to notice is that implicit in our notion of cyclical unemployment is a dependence on the prevailing wage rate. With this view of the labor market, the wage changes due to shifts of labor supply and/or
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This note was uploaded on 03/08/2011 for the course ECON 602 taught by Professor Chugh during the Spring '11 term at Johns Hopkins.

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Chapter11 - Chapter 11 The Phillips Curve One recurring...

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