Question

Based on the 'early incarnation' or original Phillips curve, please explain what effect an increase in the unemployment rate will have on the inflation rate.

Answer 1

Philips curve shows the tradeoff between unemployment and inflation and based on the early incarnation an increase in the unemployment rate will lead to a lower inflation rate whereas the modified curve states that increased unemployment will induce decreasing inflation.

W.H.Philips during his study of wage inflation and unemployment in the UK from 1851 -1957 observed an inverse relationship between unemployment and wages. He was of the opinion that when the unemployment level is low then the firms try to increase the wages so as to attract the scarce resource, that is labor. He first showed the relationship of unemployment and wages over the business cycle and hence the relationship of wage inflation and employment. Economists around the globe started applying the curve to developed countries and used inflation and unemployment as the variables.