Question

Which of the following statements are true? Which are false? Explain (for each statement)

1. According to the Phillips curve, in the long run there is a trade-off between inflation and unemployment
2. Phillips curve represents a structural relationship between unemployment and inflation that never changes.
3. Unemployment rate counts all people who do not have jobs.

Answer 1

First statement is incorrect. In the long run there is no trade off between inflation and unemployment. The reason is that in the long run prices and wages are fully flexible and the economy adjusts in the long run to any changes in output and employment in the short run which deviates it from its natural levels. Hence in long run, economy is at its potential level and so a long run Philips curve is vertical.

Second statement is also incorrect. The Philips curve does represent a relationship between unemployment and inflation (an inverse relationship). However it does change from the short run to the long run. In short run the inverse relationship applies. In the long run no trade off exists and so we can say that the relationship changes in the long run.

Third statement is incorrect. Unemployment does not count everybody who does not have a job because many people choose not be employed because of various reasons. Students who are adult could be pursuing higher education and choose to be unemployed. Some people who are adults could just choose to stay at home and do household and not have jobs. This people are not considered unemployed. So only people who do not have jobs even though they want one and are looking for one are considered as unemployed. Voluntarily unemployed people are not part of unemployment rate.