Question

1. Describe, in your own words, the Phillips Curve. What does the slope of the Phillips curve tell you? Draw the curve and mark the axes correctly.

2. Consider a very flat (almost horizontal) Phillips curve. What could go wrong if policymakers looked only at inflation rates to determine if an intervention in the economy is required?

Answer 1

Part A

The Philips curve is the economic concept developed by A.W.Philips; it shows that the inverse relationship between inflation and unemployment. The theory argues that the economic is experiencing growth with inflation then the economy’s unemployment would be less. The slope of the Philips curve describes the speed of adjustment of price. The Philips curve shows in the following diagram,

Part B

The horizontal Philips curve states that the short-run aggregate supply curve is inelastic. That means the monetary policy is neutral in this case. Suppose the aggregate supply curve is vertical in both short run and long run, then policymakers wrongly argue that it damps the effects of supply shock on inflation. In this case policy makers can’t do anything.