LU 12 inflation and unemplyoment (Aggregate Demand, Aggregate Supply, and…
LU 12 inflation and unemplyoment
Short-Run Trade off between Inflation and Unemployment.
Unemployment and Inflation
– The natural rate of unemployment depends on various features of the labor market.
– Society faces a short-run tradeoff between unemployment and inflation.
The Phillips Curve
shows the short-run trade-off between inflation and unemployment.
Aggregate Demand, Aggregate Supply, and the Phillips Curve
• Phillips curve shows the short-run combinations of unemployment and inflation that arise as shifts in AD curve move the economy along the short-run AS curve
• The greater the AD for goods and services, the greater is the economy’s output, and the higher is the overall price level
The Long-Run Phillips Curve
• As a result, the long-run Phillips curve is vertical at the natural rate of unemployment.
• Monetary policy could be effective in the short run but not in the long run.
The Short-Run Phillips Curve
The Unemployment Rate = Natural Rate of unemployment – a (Actual Inflation – Expected Inflation)
The Natural Experiment for the Natural-Rate Hypothesis
• The view that unemployment eventually returns to its natural rate, regardless of the rate of inflation, is called the natural-rate hypothesis.
The Cost Of Reducing Inflation
– When the BNM slows the rate of money growth, it contracts AD.
– This reduces the quantity of goods and services that firms produce.
– This leads to a rise in unemployment.
Shifts In The Phillips Curve: The Role Of Supply Shocks
• Historical events have shown that the short-run Phillips curve can shift due to changes in expectations.
• The short-run Phillips curve also shifts because of shocks to AS.
The Sacrifice Ratio
The sacrifice ratio is the number of percentage points of annual output that is lost in the process of reducing inflation by one percentage point.