1. Provide general overview of "Who was Alban Phillips?"
Alban Phillips was an New Zealand economist who studied at London School of Economics. He created the Moniac machine and insisted that there was an inverse relationship between the rate of change of money wages in the economy and the rate of unemployment. He is best known for Phillips curve, a curve that shows the inverse relationship between the inflation rate and the unemployment rate.
2. Explain how the Phillips curve shows the relationship of inflation and unemployment. (Provide a graph.)
<Short run Phillips Curve>
Phillips Curve shows that as unemployment rate increases, the inflation rate decreases. The first explanation for this is that if there is a low rate of unemployment, firms that hire the workers need to pay higher wages to attract them. On the other hand, if unemployment rate is high, which means there are more workers available, so the firms will pay lower wages to hire the workers. The second explanation is that there is a "trade-off" between inflation and unemployment - as one variable decreases, another increases. If, for example, the government thinks that unemployment rate is too high, it may use Keynesian demand management techniques to increase aggregate demand. The result will be a rise in output due to hiring of more workers. Therefore, unemployment is believed to decrease, while inflation rate increases.
3. Explain the criticism of the Phillips curve.
<Long Run Phillips Curve>
According to Milton Friedman and other monetarist economists, there is no trade-off between inflation and unemployment, because the economy will automatically tend towards its long-run equilibrium at the full employment level of output. (It can be seen on the graph above) If, for instance, the government decides that it will adopt an expansionary demand-side policy in order to reduce unemployment, aggregate demand will increase and will lead to a rise in demand for labor, thus an increase in wage levels. Therefore, inflation rate will rise as well, supporting Friedman's idea.
