The Phillips curve shown in the following diagram
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In
fl
at
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R
at
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(%
)
Unemployment Rate (%)
Short Run Phillips Curve
FIGURE 9.9: SHORT RUN PHILLIPS CURVE
`The unemployment rate is represented
on the X-axis and
inflation rate on the Y-axis. The Phillips curve is downward to the
right, showing the inverse relation
between inflation rate and
unemployment rate.
The economy is initially at U* with unemployment at natural
rate. Suppose the nominal
money supply is increased, the prices
and wage do not immediately rise very
much and the real money
supply increases and the rate of interest fall.
This increases the aggregate demand and output in the
short period which means that the unemployment has fallen.
In
term of diagram, economy moves from U* to A on the
Phillips curve with lower unemployment and positive inflation rate.
However, economy does not stay at point A forever.
Gradually,
wages and prices rise and reduce the real money supply. As a
result, the interest rate rise and aggregate demand falls hence
there is less and less additional upward
pressure on wages and
prices, the growth rate of unemployment increase and the economy
return back to original position of U*.
Point A was indeterminate position with higher wage inflation
and lower unemployment. Therefore, Phillips curve is a short period
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