Economics Phillips Curve Questions Long
The augmented Phillips Curve is an economic concept that builds upon the original Phillips Curve, which depicts the inverse relationship between inflation and unemployment. The augmented Phillips Curve incorporates additional factors that influence the relationship between these two variables.
The original Phillips Curve, proposed by economist A.W. Phillips in 1958, suggested that there is a trade-off between inflation and unemployment. According to this theory, when unemployment is low, inflation tends to be high, and vice versa. This relationship was based on the observation that during periods of economic expansion and low unemployment, firms face higher labor costs and tend to increase prices to maintain profitability. Conversely, during economic downturns and high unemployment, firms face lower labor costs and tend to reduce prices to attract customers.
However, the augmented Phillips Curve recognizes that the relationship between inflation and unemployment is not solely determined by the level of economic activity. It takes into account other factors that can influence inflation, such as expectations, supply shocks, and changes in the structure of the labor market.
One important factor considered in the augmented Phillips Curve is inflation expectations. It suggests that individuals and firms form expectations about future inflation based on their past experiences and economic conditions. If people expect higher inflation in the future, they may demand higher wages to compensate for the anticipated increase in prices. This can lead to a higher rate of inflation even when unemployment is high.
Another factor is supply shocks, which are sudden changes in the availability or cost of key inputs in the economy. For example, an increase in oil prices can lead to higher production costs for firms, causing them to raise prices. These supply shocks can disrupt the relationship between inflation and unemployment, as they can lead to inflationary pressures even when unemployment is high.
Changes in the structure of the labor market also play a role in the augmented Phillips Curve. Factors such as globalization, technological advancements, and changes in labor market institutions can affect the bargaining power of workers and firms. If workers have less bargaining power, they may struggle to negotiate higher wages, even when unemployment is low. This can result in lower inflation rates than predicted by the original Phillips Curve.
In summary, the augmented Phillips Curve expands upon the original concept by considering additional factors that influence the relationship between inflation and unemployment. It recognizes that inflation expectations, supply shocks, and changes in the labor market structure can impact the trade-off between these two variables. By incorporating these factors, the augmented Phillips Curve provides a more comprehensive understanding of the dynamics between inflation and unemployment in an economy.