M.com Part 1 (Semester 2)
MACROECONOMIC
Most Important Question Bank for Current Exam
13. Write
a note on the collapse of the Phillips Curve Hypothesis.
ANS:
The
Phillips Curve hypothesis was accepted as a cure to increase
the level of employment and income in the sixties. It became
a macroeconomic tool to explain the trade-off between inflation
rate and unemployment rate. It suggested that policy makers
could choose different combinations of unemployment inflation
rates. Policy makers may choose low unemployment and high
inflation if it is politically and economically expedient. However, the
stable relationship between higher inflation and lower unemployment
as seen in the sixties could not be replicated in the seventies
and thereafter, particularly in the United States and Great Britain.
It was seen that both inflation rate and unemployment rate had
increased on numerous occasions and the tradeoff had thus disappeared.
Further, there cannot be a long run trade-off between inflation
and unemployment because in the long run the aggregate supply
curve becomes vertical and any further expansion after the point
of full employment is reached will only add to the price level without
adding anything to income, employment and output. Thus, there
is no permanent unemployment-inflation trade-off. Data obtained
in the seventies and thereafter indicated a shift in the Phillips
curve i.e. in various years, at a given rate of inflation, the Phillips
curve either shifted to the left or to the right, indicating thereby
that at times, given the inflation rate, unemployment rate has
increased or decreased. The stable relationship between inflation
rate and unemployment rate thus was proved to be nonexistent.
Causes
of Shift in Phillips Curve
The
shifts in the Phillips curve according to Keynesians is due
to adverse supply shocks experienced in the seventies in the form
of unprecedented oil price hikes. Adverse supply shocks gave rise
to the phenomenon of Stagflation and the breakdown of the Phillips
curve hypothesis. The impact of adverse supply shocks on national
product and the price level is depicted in Fig. 2.3. The original
aggregate demand and supply curves AD0 and AS0 are in equilibrium
at point E0. Accordingly, the price level P0 and national output
Y0 is determined. The oil price hike initiated by the Oil and Petroleum
Exporting Countries (OPEC) an oil cartel of oil producing Middle
East countries contributed to the rise in cost of production of many
goods and services in which oil is used as an input. Increase in
the cost of production caused the aggregate supply curve to shift to
the left in the upward direction, thereby causing the price level to rise
along with a decrease in national output. Notice that the new aggregate
supply curve AS1 now intersects the aggregate demand curve
AD0 at point E1 and accordingly the new price level P1 is
determined.
However, at a higher price level P1, the national output has
fallen to Y1 leading to rise in unemployment. Such a situation is
explained in terms of stagflation where in both unemployment and
price level increases. This new phenomenon experienced, particularly
by the United States in the seventies and thereafter has caused
the shift in the Phillips curve. Stagflation, thus, consigned the
Phillips curve hypothesis to the pages of economic history.
Contact 8652719712 / 8779537141
The
Phillips Curve hypothesis was accepted as a cure to increase
the level of employment and income in the sixties. It became
a macroeconomic tool to explain the trade-off between inflation
rate and unemployment rate. It suggested that policy makers
could choose different combinations of unemployment inflation
rates. Policy makers may choose low unemployment and high
inflation if it is politically and economically expedient. However, the
stable relationship between higher inflation and lower unemployment
as seen in the sixties could not be replicated in the seventies
and thereafter, particularly in the United States and Great Britain.
It was seen that both inflation rate and unemployment rate had
increased on numerous occasions and the tradeoff had thus disappeared.
Further, there cannot be a long run trade-off between inflation
and unemployment because in the long run the aggregate supply
curve becomes vertical and any further expansion after the point
of full employment is reached will only add to the price level without
adding anything to income, employment and output. Thus, there
is no permanent unemployment-inflation trade-off. Data obtained
in the seventies and thereafter indicated a shift in the Phillips
curve i.e. in various years, at a given rate of inflation, the Phillips
curve either shifted to the left or to the right, indicating thereby
that at times, given the inflation rate, unemployment rate has
increased or decreased. The stable relationship between inflation
rate and unemployment rate thus was proved to be nonexistent.
Causes
of Shift in Phillips Curve
The
shifts in the Phillips curve according to Keynesians is due
to adverse supply shocks experienced in the seventies in the form
of unprecedented oil price hikes. Adverse supply shocks gave rise
to the phenomenon of Stagflation and the breakdown of the Phillips
curve hypothesis. The impact of adverse supply shocks on national
product and the price level is depicted in Fig. 2.3. The original
aggregate demand and supply curves AD0 and AS0 are in equilibrium
at point E0. Accordingly, the price level P0 and national output
Y0 is determined. The oil price hike initiated by the Oil and Petroleum
Exporting Countries (OPEC) an oil cartel of oil producing Middle
East countries contributed to the rise in cost of production of many
goods and services in which oil is used as an input. Increase in
the cost of production caused the aggregate supply curve to shift to
the left in the upward direction, thereby causing the price level to rise
along with a decrease in national output. Notice that the new aggregate
supply curve AS1 now intersects the aggregate demand curve
AD0 at point E1 and accordingly the new price level P1 is
determined.
However, at a higher price level P1, the national output has
fallen to Y1 leading to rise in unemployment. Such a situation is
explained in terms of stagflation where in both unemployment and
price level increases. This new phenomenon experienced, particularly
by the United States in the seventies and thereafter has caused
the shift in the Phillips curve. Stagflation, thus, consigned the
Phillips curve hypothesis to the pages of economic history.
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Suraj Patel Education :- https://t.me/surajpateleducation
F.Y.J.C EXAM :- https://t.me/FYJCexam
S.Y.J.C EXAM :- https://t.me/SYJCexam
F.Y EXAM :- https://t.me/fyexam
S.Y EXAM :- https://t.me/syexam
T.Y EXAM :- https://t.me/tyexam
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