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Unformatted text preview: CHAPTER 8 The Natural Rate of Unemployment and the Philips Curve 1 of 34 Inflation, Expected Inflation, and Unemployment The above equation is the aggregate supply. This relation can be rewritten to establish a relation between inflation, expected inflation, and the unemployment rate. 2 of 34 P P F u z e = + ( ) ( , ) 1 μ F u z z ( , ) =  + 1 α u First, the function F , assumes the form: (1 )(1 u+z) e P P μ α = + Then, replace this function in the one above: 81 Inflation, Expected Inflation, and Unemployment The appendix of the book shows how to go from the equation above to the relation between inflation, expected inflation, and the unemployment rate below. You do not need to know the derivation. 3 of 34 π π μ α = + +  e z ( ) u P P e = +  ( )( ) 1 1 μ α u+ z Inflation, Expected Inflation, and Unemployment According to this equation: An increase in the expected inflation, π e , leads to an increase in inflation, π . Given expected inflation π e , an increase in the markup, μ , or an increase in the factors that affect wage determination, z, lead to an increase in inflation π . Given expected inflation, π e , an increase in the unemployment rate, u, leads to a decrease in inflation, π . 4 of 34 π π μ α = + +  e z ( ) u Inflation, Expected Inflation, and Unemployment When referring to inflation, expected inflation, or unemployment in a specific year, the equation above needs to include time indexes, as follows: 5 of 34 π π μ α = + +  e z ( ) u π π μ α t e t t z = + +  ( ) u The variables The variables π π , , π π e t , and , and u u t refer to inflation, refer to inflation, expected inflation and unemployment in year expected inflation and unemployment in year t t ....
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This note was uploaded on 03/22/2012 for the course ECONOMICS 202 taught by Professor Pinarderingure during the Spring '12 term at Middle East Technical University.
 Spring '12
 PINARDERINGURE
 Macroeconomics, Inflation, Unemployment

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