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Phillips Curve

Phillips Curve

Phillips Curve deals with the relationship between unemployment and inflation in an economy. It was study on The British Economy between the periods 1861- 1957. The study states that the lower the rate of unemployment in an economy the higher the rate of increase in wages and the higher the rate of unemployment the lower the rate of increase in wages. It was observed that there was a stable tradeoff in the short run between unemployment and inflation, this has not been observed in the long run.

Phillips Curve was named after William Phillips, a New Zealand born economist wrote a paper in 1958 titled ‘The Relationship Between Unemployment and the Rate of Change of Money Wages in the United Kingdom 1861 – 1957’. This paper was published quarterly in the journal Economica. In this paper Philips discussed the inverse relationship between money wage changes and unemployment in the British economy over the period examined. Similar patterns were found in other countries and so this theory got accepted and the curve came to be known as The Phillips Curve.

Phillips observed that the lower the unemployment rate, the tighter the labor market and, therefore, the faster firms must raise wages to attract scarce labor. At higher rates of unemployment, the pressure reduced. Phillips’s “curve” represented the average relationship between unemployment and wage behavior over the business cycle. It showed the rate of wage inflation that would result if a certain level of unemployment continued for some time.

Although the discovery was based on the data for United Kingdom, researchers quickly extended this finding to other countries. Two years after the article was published, economists Paul Samuelson and Robert Solow published an article in the American Economic Review called “Analysis of Anti-inflation Policy” in which they showed similar negative correlation between inflation and unemployment in data for the United States. They reasoned that this correlation arose because low unemployment was associated with high aggregate demand, which in turn puts upward pressure on wages and prices throughout the economy.

Samuelson and Solow believed that the Phillips Curve gave valuable lessons to policy-makers of possible economic outcomes. By altering monetary and fiscal policy to influence aggregate demand, policymakers could choose any point on this curve. Point A offers High employment and low inflation and point B offers Low employment and high inflation.

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