• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Discuss the relationship between unemployment and inflation. To what extent is the Phillips curve still relevant?

Extracts from this document...

Introduction

Discuss the relationship between unemployment and inflation. To what extent is the Phillips curve still relevant? Professor Phillips, using figures from the 1870s to the 1950s showed that there was a relationship between unemployment and inflation, and using the data collected, modelled this relationship on a curve, which became known as the Phillips curve. The basic theory was that attempts to reduce unemployment would lead to a rise in the general price level, or inflation, and vice-versa. The Phillips curve is shown below: Inflation and unemployment both have a negative effect on the economy, if either factor is high. Both factors have a negative effect on economic growth. Unemployment is the existence of a section of the labour force, who are willing and able to work but who, for some reason, are unemployed. In the UK unemployment is measured using two methods: The Claimant Count and The Labour Force Survey. Inflation is a sustained rise in the general price level, or a sustained fall in the purchasing power of money. ...read more.

Middle

To achieve a permanent reduction you must use supply side policies. The New Classical view is that not only is the Phillips curve vertical in the long run, but also in the short run, and that there is no place for demand management policies because even in the short run the only effect of an increase in aggregate demand will be a rise in prices. The two assumptions of this model are that wages and prices are flexible, and that expectations are rational. The new classical economists believe that the markets will clear instantaneously and that there is no disequilibrium unemployment. All unemployment is therefore `voluntary unemployment' as people choose not to take jobs due to a lack of incentives to do so. Rational expectations are expectations that are based on the current situations. These expectations are based on the information at hand. While this information may be imperfect and therefore people will make errors, these errors will be random. ...read more.

Conclusion

If people expect a more rapid rise in AD to be sustained, firms will invest more, thereby reducing unemployment in the long run and not just increasing the rate of inflation. The long run Phillips curve will thus be downward sloping. The short and long run Phillips curve may be kinked. Reductions in real aggregate demand may only have a slight affect on inflation if real wages are sticky downwards. From about 1966 the Phillips curve relationship seemed to break down. The UK and many other countries in the western world too, began to experience growing unemployment and higher rates of inflation as well. From 1993-2002 the Phillips curve has been horizontal with ever falling unemployment and stable inflation. The explanation for this is as follows. NAIRU (non accelerating inflation rate of unemployment) depends on institutional factors in economy e.g. strength of trade unions, flexibility in labour markers, labour mobility, social security system, education and training, and the taxation system. These are called supply side factors. Improving the supply side reduces NAIRU so unemployment can fall while inflation stays stable. This is shown in the diagram below. [image001. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Peer reviewed

    How can inflation be reduced?

    5 star(s)

    mentioned earlier one tactic is to lower income tax (therefore give more incentive to work). However classical economists have devised many other methods to encourage high production. One method is too weaken the power of trade unions (which can become a monopsonist when there is one buyer yet many sellers).

  2. Budget 2004-05 and Economic Analysis of Pakistan

    head in the Budget 2004-2005 has been projected at Rs 48767 million. This is 10.9% lower than the revised estimates of 2003-2004 mainly because of reduced allocation in respect of General Economic, Commercial and Labor Affairs. The following table provides the details under this head: (Rs.in Million)

  1. Inflation vs. Unemployment - In what way might there be a trade off ...

    Throughout times of inflation savers are worse off than borrowers. There are other causes of demand but they are not relevant to the essay, this because it would deviate too much from the question. The relation between inflation and unemployment can be defined best by the work of an economist called Bill Philips.

  2. To what extent does the government budget/statement reflect current government priorities?

    As Britain's industry continues to expand and destroy most of our beloved countryside and pollute our skies, pressure groups and environmentalists increase the strain on the government to protect and instigate new legislation to help reduce the effects of the unstoppable industry.

  1. What ended hyperinflation in Germany, Austria and Hungary in the 1920s? Do the facts ...

    The loss of territory also led to segments of textile industry in different countries and raw materials supplies separated from industrial centers. Moreover, large-scale unemployment caused serious problems for postwar activities and the new national border. As the loser of the war, Austria also owed a huge amount of reparation.

  2. What are the main differences between the 'natural rate of unemployment' and the 'NAIRU' ...

    Moreover, higher wages may help the firm to retain and recruit workers and to maintain profits by reducing quits. Secondly, unions play a significant role in setting wages, especially in Europe, where in some countries over three quarters of the workforce have wages that are covered by the collective bargaining.

  1. Discuss the idea that if the economyis to prosper in the long run, the ...

    Both of these examples take time, effort and money. The effects of this will be hugely significant to a large supermarket chain that would have to alter their prices in order to accommodate the cost increase incurred by inflation. The costs of anticipated inflation do not appear to warrant the importance that Governments have attached to the reduction of inflation.

  2. Keynesian theory

    This rapid increase in investment is attainable through fiscal deficit ? which Keynes believed (if done purposefully and methodically) would aid an economy in recession. The fiscal deficit would come as a result of the issuing of government bonds (the revenue from which would be used to fund the government?s injection into the economy.)

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work