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Unformatted text preview: 1 171 The Phillips Curve and Aggregate Supply 172 Agenda 1. The Phillips Curve 2. The Aggregate Supply Curve 173 The Phillips Curve The Phillips curve is the inverse relationship between inflation and unemployment . 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. 174 The Phillips Curve The Phillips curve is given by: where: 1. = inflation, 2. U = the unemployment rate, and 3. = the sensitivity of to changes in U. =  U 2 175 The Phillips Curve 176 The Phillips Curve The Phillips curve also implies an inverse relationship between: 1. Nominal wages and 2. Unemployment. 177 The Phillips Curve A major flaw in the original Phillips curve analysis was that it failed to distinguish between nominal wages and real wages. 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. 178 The Phillips Curve This suggests there is a positive oneforone relationship between: 1. Wages and inflation, and 2. Expected inflation . 3 179 The Phillips Curve In the longrun , when all wages and prices are completely flexible, unemployment would be at the natural rate of unemployment, U N . This is also called the fullemployment level of unemployment. This is the unemployment rate consistent with the economys longrun steady state. 1710 The Phillips Curve Incorporating these changes, the Phillips Curve becomes the expectationsaugmented Phillips curve , which is given by: i.e., inflation is: 1. Positively related to expected inflation , and 2. Inversely related to the unemployment gap, U  U N . = e ( U U N ) e , 1711 The Phillips Curve The expectationsaugmented Phillips curve: implies that: 1. when U = U N 2. then = e ( U U N ) = e 1712 The Phillips Curve Because in the longrun, U = U...
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This note was uploaded on 03/13/2012 for the course ECON 100B taught by Professor Wood during the Fall '08 term at University of California, Berkeley.
 Fall '08
 Wood

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