Question

Discuss the trade-off between inflation and unemployment using Phillips curves.

Answer 1

The Phillips curve given by A.W. Phillips shows that there exist an inverse relationship between the rate of unemployment and the rate of increase in nominal wages.

A lower rate of unemployment is associated with higher wage rate or inflation, and vice versa. In other words, there is a tradeoff between wage inflation and unemployment.

Since Phillips curve shows a trade off between inflation and unemployment rate, any attempt to solve the problem of inflation will lead to an increase in the unemployment. Similarly, any attempt to decrease unemployment will aggravate inflation. Thus, the negative sloped Phillips Curve suggested that the policy makers in the short run could choose different combinations of unemployment and inflation rates.

In the long run, however, permanent unemployment – inflation trade off is not possible because in the long run Phillips curve is vertical. Since in the short run AS curve (Phillips Curve) is quite flat, therefore, a trade off between unemployment and inflation rate is possible. It offers the policy makers to chose a combination of appropriate rate of unemployment and inflation.

The inverse relationship between unemployment and inflation is depicted as a downward sloping, concave curve, with inflation on the Y-axis and unemployment on the X-axis.