Question

Unemployment and inflation are often seen as tradeoffs for each other. Explain their relationship and give examples of then they do move in opposite directions (one goes up when the other goes down), provide an example of than the move in the same direction (both go up together).

Answer 1

Phillips curve shows the trade-off between unemployment rate and inflation . It shows that in short run there is an inverse relationship between the inflation rate , this means that when inflation increases ,unemployment rate decreases and when inflation decreases ,unemployment rate increases .This can be illustrated from the following graph :-

In the above graph we can see that as soon as inflation rate rises from the unemployment rate decreases from r to r1.

Example of Phillips curve ( inverse relationship ):-

From 1861 to 1960 Phillips curve accurately predicted rates of inflation and unemployment.

Exceptions to Phillips curve ( movement in same direction):-

1) France oil crisis inflation in 1970's and 80's where inflation and unemployment rate both increased.

2) 1970's UK stagflation which resulted in high inflation and high unemployment rates .