In 1958, A.W. Phillips stated that inflation and unemployment are correlated. In
ID: 1206734 • Letter: I
Question
In 1958, A.W. Phillips stated that inflation and unemployment are correlated. In 1972, Milton Friedman stated that Phillips' relationship was only temporary, and thus only applicable in the short-run. Friedman contended that people will over time anticipate the correct value of inflation and in the meantime adjust their actions accordingly. These expectations mitigate policymakers' attempts to control unemployment through inflationary policies. Thus, Friedman believed that in the long-run, there is no relationship between inflation and unemployment. Friedman's analysis of inflation and unemployment is summarized by the following equation:
Which of the answer choices is Phillips' theory regarding inflation and unemployment?
A. More people working in an economy correlates to more expensive goods and services.
B. Fewer people looking for work in an economy correlates to cheaper goods and services.
C. More people looking for work in an economy correlates to more expensive goods and services
D. Fewer people working in an economy correlates to more expensive goods and services.
At the end of 2014, the unemployment rate in the U.S. was 5%. The Federal Reserve has stated that it will conduct monetary policy to bring down this unemployment rate during 2015. Suppose that the natural rate of unemployment is 6%, the value of a is one, and the public expects inflation of 4%. According to the given information, which of the answer choices correctly gives values of actual inflation that would support Phillips’ theory and Friedman’s theory, respectively?
A. Phillips: 6%; Friedman: 5%
B.Phillips: 7%; Friedman: 6%
C. Phillips: 5%; Friedman: 2%
D. Phillips: 3%; Friedman: 4%
Explanation / Answer
a) According to phillip theory of inflation and unemployment, there is an inverse relationship between rates of unemployment and the corresponding rates of inflation that results within an economy. Simply stated decresed rate of inflation will correspond with increased rate of inflation in an economy. So from the options, option 'A' fits the best i.e more people working in an economy correlates to more expensive goods and services.
b) According to the phillip curve equation,
y = y' + a( p - pe)
or y- ya = a ( p - pe)
differentating
y' = a p'
where y' inflation rate and p' is unemployment rate
a = 1
inflation rate = 6 %
there fore from the option
option 'a' Phillips: 6% and Friedman : 5%
PS: Don't know the equation of the friedman equation or else i would have solved it separately.