ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The Phillips curve shows the short-run trade-off between inflation and unemployment. The Phillips curve shows the short-run combinations of unemployment and inflation that arise as shifts in the aggregate demand curve move the economy along the short-run aggregate supply curve.

Detailed explanation-2: -Since inflation is higher for any level of unemployment the trade-off becomes less favourable the inflation rate rises for any level of unemployment. Compare points N and N’. Since people adjust their expectations of inflation over time, there is a trade-off between inflation and unemployment only in the short run.

Detailed explanation-3: -The Phillips curve shows the relationship between inflation and unemployment. In the short-run, inflation and unemployment are inversely related; as one quantity increases, the other decreases. In the long-run, there is no trade-off.

Detailed explanation-4: -Why is there no long-run trade-off between unemployment and inflation? The LRPC does not show a trade-off between unemployment and inflation because the expected inflation adjusts so that the unemployment rate returns to the natural level of unemployment or NAIRU.

Detailed explanation-5: -In the short run, expectations are somewhat fixed. Thus, when the Fed increases the money supply, aggregate demand increases along the upward sloping short-run aggregate-supply curve. Output grows (unemployment falls) and the price level rises (inflation increases).