Question

According to the study of Aggregate Supply Curve and the Phillips Curve, a number of different models justifies the existence of sticky wages and also the ability of aggregate demand curve to affect output.
(a) Explain these models.
(b) What are their similarities and differences ?
(c) Which of these models do you find the most plausible ?

Discuss the main differences between the original expectations-augmented Phillips Curve and the curve built on Rational Expectations.

Answer 1

Answer:

a)Explanation of both the Models:

Aggregate Supply Curve:

The aggregate supply curve refers to the positive relationship between the price level of a good and the quantity of output provided by the firm. Where total output includes the supply of goods and services at certain price levels over a period of time. There are two types of aggregate supply curve:

Short-run aggregate supply curve:

In the short run aggregate supply curve the quantity of the goods and the services increases with the rise in the price levels beause of the curve moves upwards to the right side as shown in the figure below.

Long-run aggregate supply curve:

In the long run aggregate supply curve there will be no changes in the quantity of output with the changes in prices . That is the prices and wages can be flexible but the quantity of goods and services supplied remains constant which can be explained further in the below image.

Hence there is lot of difference in between long run and short run aggregate supply curve.

Phillips Curve:

The Phillips curve explains that the increase in the wage rate leads to the increase in unemployment. There is an inverse relationship between inflation rate and unemployement rate with the long run ans short run Phillips Curve model explains below.

Long-run Phillips curve:

In the long run Phillips curve the unemployment rate will remain constant where as the inflation rate will be fluctuating high or low as explained in the figure below.

Short - run Phillips Curve:

In the short run Phillips curve the Unemployment rate will be fluctuating along with the fluctuations in the inflation rate as explained in the figure below:

b)Similarities and Differences in between Aggregate Supply Curve and Phillips Curve:

Similarities:

The similarity between aggregate supply curve is in both the models long run aggregate supply remains constant with rise in price levels as well as in the long run Phillips curve the Unemployment remains constant with the fluctuation in the inflation rate.

Differences:

The differences between the aggregate supply curve and Phillips Curve are they both explains and study about different criteria the Aggregate supply curve model studies about the changes in the quantity supplied with the changes in the price level within the short and long run period of time whereas the Phillips curve model explains about the inverse relationship between the inflation rate and unemployment rate in the long and short run period of time.

c) The most plausable model:

According to me and the explanation the most plausable model is Aggregate supply curve model because It gives the economic growth with the growth in the GDP with increase in the price levels and supply of goods as well as services. Whereas in the other model which is the Phillips curve only discuss about the unemployment issue. Most of the economists also rejected and objected the Phillips curve model.

Main differences between the Original Expectations - Augmented Phillips Curve and the curve built on the Rational expectations:

As we discussed about the original phillips curve which explains that the higher the inflation the higher the unployment rate. But in Expectations-augmented Phillips curve states that the with the increase in the actual wages will also increase in the expected wage rate. Which is nothing but there will be increase in the expected inflation rate with increase in the actual inflation rate. According to the Rational expectations of the Phillips curve there will be no trade off even in the short run Phillips curve because people are aware of the policies related to employment and unemployment impacts.