This was in contrast to both Phillips curve style and the effortless Keynesian model

In fact Phillips themselves if you find yourself sharing the connection anywhere between rising cost of living and you can jobless, believed the partnership ranging from rates out of upsurge in wage speed (because the an effective proxy for the rate of rising prices) on the one hand and you can unemployment rate on the other

Throughout step one970s a mysterious occurrence is experienced in the us and Britain whenever here existed a higher rate out of infla­tion alongside with high jobless speed.

That it multiple lives away from both high rate out of rising cost of living and you may highest jobless speed (or low level off real national device) into the seventies and you can early 80s might have been referred to as stagflation.

Let’s very first bring a description into the Phillips curve. Each other Keynesians and Monetarists offered to the presence of the newest Phillips curve. 25.step three.

The rationale of Phillips curve because of the Keynesian economists is quite simple and easy was graphically portrayed inside Fig

It could be detailed you to Keynesian economists suppose the newest upward-slanting aggregate supply contour. Actually, Keynes himself accepted that curve As is upward slanting inside intermediate diversity, that’s, since benefit approaches near complete a position height, brand new aggregate also have curve hills up.

According to Keynesian econo­mists, aggregate supply curve is upward sloping for two reasons. First, as output is increased by the firms in the economy, diminishing returns to variable factors, especially to labour, accrue resulting in fall in marginal physical product (MPP_L) of labour. With money wage rate (W) as given and ‘ fixed, the fall in the marginal physical product of labour causes the rise in the marginal cost (MC) of production (Note that MC= W/MPP_L). With the fall in the MPP of labour, wage rate remaining constant, the term W/MPP_L measuring marginal cost (MC) will rise.

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The second factor in the fresh new marginal prices to go up try the rise on the wage speed while the a position and you will productivity was enhanced. When under some pressure regarding aggregate demand for efficiency, demand for labor increases their salary rates is likely to increase, have curve out of work are upward slanting.

Even Keynes themselves thought that due to the fact discount approached close full employment, labor lack might appear in some circles of your economy causing boost in new salary rate. For this reason, marginal cost of businesses expands as more work is employed owed so you can diminishing limited physical product of labor and now have due to the fact wage rate along with rises.

Now, it will be seen from panel (a) of Fig. 25.3 that with the initial aggregate demand curve AD₀ and the given aggregate supply curve AS, the price level P_o and output level Y₀ are determined. Now, suppose the aggregate demand curve increases from AD₀ to AD₁, it will be seen that price level rises to P₁ and aggregate national output increases from Y₀ to Y₁.

Note that increase in aggre­gate national product means increase in employment of labour and therefore reduction in unem­ployment rate. Thus the rise in the price level from P₀ to P₁ (i.e., occurrence of inflation) results in lowering of unemployment rate showing inverse relation between the two.

Further, if aggregate demand increases to AD₂, the price level further rises to P₂ and national output increases to Y₂ which will further lower the rate of unemployment. The greater the rate at which aggregate demand increases, the higher will be the rate of inflation which will cause greater increase in aggregate output and employment resulting in much lower rate of unemployment.

Thus, a higher rate of increase in aggregate demand and consequently a higher rate of rise in price level is associated with the lower rate of unemployment and vice-versa. This is what is represented by Phillips curved Consider panel (b) of Fig. 25.3 where point a’ on the downward sloping Phillips curve PC corre­sponds to point a of panel (a) of Fig. 25.3. In panel (b) of the Fig. 25.3 we have shown the-fate of unemployment equal to U₃ corresponding to the price level P₀ of panel (a). When the aggregate demand shifts to AD₁ there is a certain rate of inflation and price level rises to P₁ and aggregate output expands toY₁. As seen above, this increase in aggregate output leads to the increase in employment of labour bringing about decline in unemployment rate.