Question

The Phillips curve is one of the most cited relationships in macroeconomics, relating the output

gap (i.e. short-run output) to inflation.

a. In a diagram, illustrate two different Phillips curves: one that relatively steep and one that

is relatively flat.

b. Compare how the two different economies represented by the curves would respond to a

boom and to a slump (or slowdown).

c. In recent years, economists have estimated that the Phillips curve has flattened in the

United States. Given your answers for (a) and (b), what does that imply about the

relationship between inflation and short-run output for the US economy?

d. If we use an alternative (and more common) Phillips curve in which the change in

inflation is compared against cyclical unemployment (rather than short run output),

would you expect this graph to be positively or negatively sloped? Explain. Hint –

Google image search Philips curve and the first result will likely verify your answer

Answer 1

a) Steep Philips curve and flat philips curve diagram given.

b)The policy makers of the two countries has the alternative of prioritising inflation or unemployment during boom and slump.The policy makers could use fiscal and monetary policy to manage rate of growth and inflation during boom and slump..If unemployment was high and inflation low,policy makers would increase aggregate demand . This would reduce unemployment but inflation will increase and vice versa.

c)There is inverse relation between inflation and short run output.When inflation is high , output is less and when inflation is low output is high.So the philips curve is flat.So in US in the short run ,there is inverse relation between inflation and unemployment and the Phillips curve is downward sloping ie negatively sloped .Higher unemployment means lower inflation and vice versa.In the long run this relationship does not hold and the economy goes back to natural rate of unemployment regardless of inflation.

d) There is inverse relation between inflation and output when the philip curve is flat.Since the US philips curve is flat we can say that inflation is low ,output is less .