{"id":2266,"date":"2015-06-19T21:12:00","date_gmt":"2015-06-19T21:12:00","guid":{"rendered":"https:\/\/courses.candelalearning.com\/masterymacro1xngcxmaster\/?post_type=chapter&p=2266"},"modified":"2016-07-28T21:10:20","modified_gmt":"2016-07-28T21:10:20","slug":"policy-implications-of-the-neoclassical-perspective-phillips-curve-tradeoff","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-hccc-macroeconomics\/chapter\/policy-implications-of-the-neoclassical-perspective-phillips-curve-tradeoff\/","title":{"raw":"Reading: Policy Implications: No Phillips Curve Tradeoff","rendered":"Reading: Policy Implications: No Phillips Curve Tradeoff"},"content":{"raw":"
\r\n
\r\n
\r\n

The Neoclassical Phillips Curve Tradeoff<\/span><\/h2>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\nThe Keynesian Perspective introduced the Phillips curve<\/em><\/a> and explained how it is derived from the aggregate supply curve. The short run upward sloping aggregate supply curve implies a downward sloping Phillips curve; thus, there is a tradeoff between inflation and unemployment in the short run. By contrast, a neoclassical long-run aggregate supply curve will imply a vertical shape for the Phillips curve, indicating no long run tradeoff between inflation and unemployment. Figure\u00a012.6 (a) shows the vertical AS curve, with three different levels of aggregate demand, resulting in three different equilibria, at three different price levels. At every point along that vertical AS curve, potential GDP and the rate of unemployment remains the same. Assume that for this economy, the natural rate of unemployment is 5%. As a result, the long-run Phillips curve relationship, shown in Figure\u00a012.6 (b), is a vertical line, rising up from 5% unemployment, at any level of inflation.\r\n
\r\n
\r\n\r\n[caption id=\"attachment_4608\" align=\"aligncenter\" width=\"780\"]\"The Figure 12.6.<\/strong> From a Long-Run AS Curve to a Long-Run Phillips Curve. (a) With a vertical AS curve, shifts in aggregate demand do not alter the level of output but do lead to changes in the price level. Because output is unchanged between the equilibria E0, E1, and E2, all unemployment in this economy will be due to the natural rate of unemployment. (b) If the natural rate of unemployment is 5%, then the Phillips curve will be vertical. That is, regardless of changes in the price level, the unemployment rate remains at 5%.[\/caption]\r\n\r\n<\/div>\r\n<\/div>\r\n

TRACKING INFLATION AND UNEMPLOYMENT RATES<\/h3>\r\nSuppose that you have collected data for years on the rates of inflation and unemployment and recorded them in a table, such as Table\u00a012.1. How do you interpret that information?\r\n
\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Table <\/span>12.2.<\/span><\/caption>\r\n
Year<\/th>\r\nInflation Rate<\/th>\r\nUnemployment Rate<\/th>\r\n<\/tr>\r\n<\/thead>\r\n
1970<\/td>\r\n2%<\/td>\r\n4%<\/td>\r\n<\/tr>\r\n
1975<\/td>\r\n3%<\/td>\r\n3%<\/td>\r\n<\/tr>\r\n
1980<\/td>\r\n2%<\/td>\r\n4%<\/td>\r\n<\/tr>\r\n
1985<\/td>\r\n1%<\/td>\r\n6%<\/td>\r\n<\/tr>\r\n
1990<\/td>\r\n1%<\/td>\r\n4%<\/td>\r\n<\/tr>\r\n
1995<\/td>\r\n4%<\/td>\r\n2%<\/td>\r\n<\/tr>\r\n
2000<\/td>\r\n5%<\/td>\r\n4%<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\nStep 1.<\/strong> Plot the data points in a graph with inflation rate on the vertical axis and unemployment rate on the horizontal axis. Your graph will appear similar to Figure\u00a012.7.\r\n
\r\n
\r\n\r\n[caption id=\"attachment_4609\" align=\"aligncenter\" width=\"390\"]\"This Figure 12.7. Inflation Rates<\/strong>[\/caption]\r\n\r\n<\/div>\r\n<\/div>\r\nStep 2.<\/strong> What patterns do you see in the data? You should notice that there are years when unemployment falls but inflation rises, and other years where unemployment rises and inflation falls.\r\n\r\nStep 3.<\/strong> Can you determine the natural rate of unemployment from the data or from the graph? As you analyze the graph, it appears that the natural rate of unemployment lies at 4%; this is the rate that the economy appears to adjust back to after an apparent change in the economy. For example, in 1975 the economy appeared to have an increase in aggregate demand; the unemployment rate fell to 3% but inflation increased from 2% to 3%. By 1980, the economy had adjusted back to 4% unemployment and the inflation rate had returned to 2%. In 1985, the economy looks to have suffered a recession as unemployment rose to 6% and inflation fell to 1%. This would be consistent with a decrease in aggregate demand. By 1990, the economy recovered back to 4% unemployment, but at a lower inflation rate of 1%. In 1995 the economy again rebounded and unemployment fell to 2%, but inflation increased to 4%, which is consistent with a large increase in aggregate demand. The economy adjusted back to 4% unemployment but at a higher rate of inflation of 5%. Then in 2000, both unemployment and inflation increased to 5% and 4%, respectively.\r\n\r\nStep 4.<\/strong> Do you see the Phillips curve(s) in the data? If we trace the downward sloping trend of data points, we could see a short-run Phillips curve that exhibits the inverse tradeoff between higher unemployment and lower inflation rates. If we trace the vertical line of data points, we could see a long-run Phillips curve at the 4% natural rate of unemployment.\r\n\r\nThe unemployment rate on the long-run Phillips curve will be the natural rate of unemployment. A small inflationary increase in the price level from AD0<\/sub> to AD1<\/sub> will have the same natural rate of unemployment as a larger inflationary increase in the price level from AD0<\/sub> to AD2<\/sub>. The macroeconomic equilibrium along the vertical aggregate supply curve can occur at a variety of different price levels, and the natural rate of unemployment can be consistent with all different rates of inflation. The great economist Milton Friedman<\/em><\/a> (1912\u20132006) summed up the neoclassical view of the long-term Phillips curve tradeoff in a 1967 speech: \u201c[T]here is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off.\u201d\r\n\r\nIn the Keynesian perspective, the primary focus is on getting the level of aggregate demand right in relationship to an upward-sloping aggregate supply curve. That is, AD should be adjusted so that the economy produces at its potential GDP, not so low that cyclical unemployment results and not so high that inflation results. In the neoclassical perspective, aggregate supply will determine output at potential GDP, unemployment is determined by the natural rate of unemployment churned out by the forces of supply and demand in the labor market, and shifts in aggregate demand are the primary determinant of changes in the price level.\r\n
\r\n

LINK IT UP<\/h3>\r\nVisit this website<\/a> to read about the effects of economic intervention.\r\n

Self Check: No Phillips Curve Tradeoff<\/h2>\r\nAnswer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not<\/strong> count toward your grade in the class, and you can retake it an unlimited number of times.\r\n

You\u2019ll have more success on the Self Check if you\u2019ve completed the Reading in this section.<\/span><\/p>\r\nUse this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.\r\n\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/574\r\n\r\n<\/div>","rendered":"

\n
\n
\n

The Neoclassical Phillips Curve Tradeoff<\/span><\/h2>\n<\/div>\n<\/div>\n<\/div>\n

The Keynesian Perspective introduced the Phillips curve<\/em><\/a> and explained how it is derived from the aggregate supply curve. The short run upward sloping aggregate supply curve implies a downward sloping Phillips curve; thus, there is a tradeoff between inflation and unemployment in the short run. By contrast, a neoclassical long-run aggregate supply curve will imply a vertical shape for the Phillips curve, indicating no long run tradeoff between inflation and unemployment. Figure\u00a012.6 (a) shows the vertical AS curve, with three different levels of aggregate demand, resulting in three different equilibria, at three different price levels. At every point along that vertical AS curve, potential GDP and the rate of unemployment remains the same. Assume that for this economy, the natural rate of unemployment is 5%. As a result, the long-run Phillips curve relationship, shown in Figure\u00a012.6 (b), is a vertical line, rising up from 5% unemployment, at any level of inflation.<\/p>\n

\n
\n
\"The<\/p>\n

Figure 12.6.<\/strong> From a Long-Run AS Curve to a Long-Run Phillips Curve. (a) With a vertical AS curve, shifts in aggregate demand do not alter the level of output but do lead to changes in the price level. Because output is unchanged between the equilibria E0, E1, and E2, all unemployment in this economy will be due to the natural rate of unemployment. (b) If the natural rate of unemployment is 5%, then the Phillips curve will be vertical. That is, regardless of changes in the price level, the unemployment rate remains at 5%.<\/p>\n<\/div>\n<\/div>\n<\/div>\n

TRACKING INFLATION AND UNEMPLOYMENT RATES<\/h3>\n

Suppose that you have collected data for years on the rates of inflation and unemployment and recorded them in a table, such as Table\u00a012.1. How do you interpret that information?<\/p>\n

\n\n\n\n\n\n\n\n\n\n\n\n
Table <\/span>12.2.<\/span><\/caption>\n
Year<\/th>\nInflation Rate<\/th>\nUnemployment Rate<\/th>\n<\/tr>\n<\/thead>\n
1970<\/td>\n2%<\/td>\n4%<\/td>\n<\/tr>\n
1975<\/td>\n3%<\/td>\n3%<\/td>\n<\/tr>\n
1980<\/td>\n2%<\/td>\n4%<\/td>\n<\/tr>\n
1985<\/td>\n1%<\/td>\n6%<\/td>\n<\/tr>\n
1990<\/td>\n1%<\/td>\n4%<\/td>\n<\/tr>\n
1995<\/td>\n4%<\/td>\n2%<\/td>\n<\/tr>\n
2000<\/td>\n5%<\/td>\n4%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n

Step 1.<\/strong> Plot the data points in a graph with inflation rate on the vertical axis and unemployment rate on the horizontal axis. Your graph will appear similar to Figure\u00a012.7.<\/p>\n

\n
\n
\"This<\/p>\n

Figure 12.7. Inflation Rates<\/strong><\/p>\n<\/div>\n<\/div>\n<\/div>\n

Step 2.<\/strong> What patterns do you see in the data? You should notice that there are years when unemployment falls but inflation rises, and other years where unemployment rises and inflation falls.<\/p>\n

Step 3.<\/strong> Can you determine the natural rate of unemployment from the data or from the graph? As you analyze the graph, it appears that the natural rate of unemployment lies at 4%; this is the rate that the economy appears to adjust back to after an apparent change in the economy. For example, in 1975 the economy appeared to have an increase in aggregate demand; the unemployment rate fell to 3% but inflation increased from 2% to 3%. By 1980, the economy had adjusted back to 4% unemployment and the inflation rate had returned to 2%. In 1985, the economy looks to have suffered a recession as unemployment rose to 6% and inflation fell to 1%. This would be consistent with a decrease in aggregate demand. By 1990, the economy recovered back to 4% unemployment, but at a lower inflation rate of 1%. In 1995 the economy again rebounded and unemployment fell to 2%, but inflation increased to 4%, which is consistent with a large increase in aggregate demand. The economy adjusted back to 4% unemployment but at a higher rate of inflation of 5%. Then in 2000, both unemployment and inflation increased to 5% and 4%, respectively.<\/p>\n

Step 4.<\/strong> Do you see the Phillips curve(s) in the data? If we trace the downward sloping trend of data points, we could see a short-run Phillips curve that exhibits the inverse tradeoff between higher unemployment and lower inflation rates. If we trace the vertical line of data points, we could see a long-run Phillips curve at the 4% natural rate of unemployment.<\/p>\n

The unemployment rate on the long-run Phillips curve will be the natural rate of unemployment. A small inflationary increase in the price level from AD0<\/sub> to AD1<\/sub> will have the same natural rate of unemployment as a larger inflationary increase in the price level from AD0<\/sub> to AD2<\/sub>. The macroeconomic equilibrium along the vertical aggregate supply curve can occur at a variety of different price levels, and the natural rate of unemployment can be consistent with all different rates of inflation. The great economist Milton Friedman<\/em><\/a> (1912\u20132006) summed up the neoclassical view of the long-term Phillips curve tradeoff in a 1967 speech: \u201c[T]here is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off.\u201d<\/p>\n

In the Keynesian perspective, the primary focus is on getting the level of aggregate demand right in relationship to an upward-sloping aggregate supply curve. That is, AD should be adjusted so that the economy produces at its potential GDP, not so low that cyclical unemployment results and not so high that inflation results. In the neoclassical perspective, aggregate supply will determine output at potential GDP, unemployment is determined by the natural rate of unemployment churned out by the forces of supply and demand in the labor market, and shifts in aggregate demand are the primary determinant of changes in the price level.<\/p>\n

\n

LINK IT UP<\/h3>\n

Visit this website<\/a> to read about the effects of economic intervention.<\/p>\n

Self Check: No Phillips Curve Tradeoff<\/h2>\n

Answer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not<\/strong> count toward your grade in the class, and you can retake it an unlimited number of times.<\/p>\n

You\u2019ll have more success on the Self Check if you\u2019ve completed the Reading in this section.<\/span><\/p>\n

Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.<\/p>\n

\t