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Phillips Curve

The Phillips curve presents a simple analysis of unemployment about wage inflation that showed a stable and permanent trade-off between the two. However, the Phillips curve in the U.S.A followed by many other countries began to shift upwards in the 1960s. This indicated that the correlation between the two variables was no longer stable and the concept of the Phillips curve was not accurate in the long run. This was followed by numerous debates for and against the Phillips curve economic theory.

As a result, some factors causing these shifts were identified. These include;

  • The continually rising cost of living has a great impact on the wages.
  • Price expectations. This factor was argued out by Friedman and Phelps. They concluded that the expectation that prices would rise had a direct impact on the wages.
  • Price changes. The Phillips curve was formulated with the concept that changes in wages influence a change in prices. However, it failed to consider the effect of changes in prices on the wages. Therefore, an increase in prices leads to an increase in wages.
  • Effect of the expansionary public policy. This cause the shifts through its two effects;
  1. The expansionary policy stimulates the aggregate demand hence reducing the unemployment rate. As a result, the wages increase due to the risen cost of production. This is seen as an upward movement on the Phillips curve following the short-run effect fueled by changes in the unemployment rate.
  2. Following the implementation of the policy, the increase in prices results in a rise in the cost of living which automatically increases the wages. This is known as the long-run effect of changes in the prices of wages.