Question

Consider a scenario, like in the 1970s, when oil prices go up very suddenly and very...

Consider a scenario, like in the 1970s, when oil prices go up very suddenly and very considerably. Let’s say that this causes a sudden spike in inflation.

(a) Does this imply an increase in output, based on the Phillips Curve?

(b) How does such a scenario affect the Phillips Curve?

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Answer #1

A) When there is a sudden increase in inflation rate there are changes in the expectations of inflation and so the Phillips curve shifts up. In the short run this would imply an increase in rate of inflation as well as an increase in rate of unemployment, so that output should actually fall.

b) As mentioned, short run Phillips curve shifts up. This is true because there is no change in rate of unemployment when an adverse supply shock hits the economy. Inflationary expectations are revised and so Phillips curve shifts up/rightwards

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