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    M.com Part 1 (Semester 2)

MACROECONOMIC

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15.   Explain the relationship between the short and the long run Phillips curve.
    
ANS
The position of the short run Phillips curve passing through a long run Phillips curve is determined by the anticipated or expected inflation rate. The short run Phillips curve can be compared to the short run aggregate supply curve because both the curves are drawn with a given expected price level. The short run Phillips curve drawn with an expected inflation rate shifts its position as the inflation rate changes (See figure 2.7). If the expected inflation rate is six per cent, the short run Phillips curve (SPC1) also passes through the corresponding point ‘A0’ on the long run Phillips curve with natural unemployment rate of six per cent. The movement along a short run Phillips curve is determined by changes in aggregate demand. When there is an unexpected increase in aggregate demand, the actual inflation rate is found to be more than the expected inflation rate and the real national output increases causing the unemployment rate to fall below the natural rate. The new short run equilibrium is determined at point ‘A1’ which is to the left of the original equilibrium point. Conversely, if there is an unexpected decrease in aggregate demand, the actual inflation rate will fall below the expected rate and the unemployment rate will increase and real national output will fall. In this case, the movement will be downwards and to the right. The shift in the short run Phillips curve is caused due to the divergence between actual and expected inflation rates and this divergence is caused by unexpected changes in monetary and fiscal policies of the government. If the actual inflation rate is greater than the expected inflation rate, the short run Phillips curve will shift upward and vice-versa. The distance by which the short run Phillips curve shifts to a new position is equal to the change in the expected rate of inflation.

 

 

 

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