Question

A) What is the “Natural rate” of unemployment? B) Why is a movement up the Phillips curve (that is, a reduction in unemployment below the “natural rate” at the cost of higher inflation) untenable in the very long run? Explain using Aggregate Demand and Aggregate Supply. C) What can be done to shift the Phillips curve to the left?

Answer 1

A)The natural rate of unemployment represents the lowest unemployment rate where inflation is stable..

B)The Philips curve shows the relationship between inflation and unemployment rate.However the long run Philips curve is a vertical line and it shows there is no trade off between inflation and unemployment in the long run. However the short run philips curve is L shaped and shows inverse relationship between unemployment and inflation . Since the long run philips curve is vertical ,a movement up the philips curve is untenable in the long run.The short run phillips curve shows the trade off between inflation and unemployment but the long run phillips curve shows unemployment rate stays steady even though inflation rate changes.

C)Increases in aggregate supply shift the philips curve to the left .Aggregate supply increases when there is technological improvement,decrease in expected inflation,a positive supply shock ie when agregate supply goes up because minimum wages went down.