Académique Documents
Professionnel Documents
Culture Documents
Phillip curve (1958) introduced the price function to the erst while fixed price of the
real income and interest rate determination. He carried out an empirical study on
British annual data for the period 1861 through 1957 and found negative
relationship between the rate of change in the nominal base rate and rate of
unemployment.
The wage rate (W), is expected to move directly with the gap between the aggregate
demand (ADL) for an aggregate supply of labor (ASL)
W= F (ADL-ASL)
F1>0
When the said relationship is changed to the rate of change, it would imply that the
rate of change in money wage rate is a negative function of the rate of
unemployment.
The nominal wage rate is positive related to the rate of inflation and the
unemployment rate negatively to the real income, the said relationship was
subsequently extended to the ones between the rate of inflation and rate of
unemployment (negative) and the rate of inflation and the real income (positive). In
honor of the founder all such relationship are known as PHILLIP CURVE.
Friedman argued that the Phillips curve relationship was only a short-run
phenomenon. He argued that in the long-run workers and employers will take
inflation into account, resulting in employment contracts that increase pay at rates
near anticipated inflation. Employment would then begin to fall until "full
employment" was reached, but now with higher inflation rates.
The short-term Phillips Curve looked like a normal Phillips Curve, but shifted in the
long run as expectations changed. In the long run, only a single rate of
unemployment (the NAIRU or "natural" rate) was consistent with a stable inflation
rate.
The long-run Phillips Curve was thus vertical, so there was no trade-off between
inflation and unemployment.
In the diagram, the long-run Phillips curve is the vertical red line. The
NAIRU (non-accelerating inflation rate of unemployment) theory says that when
unemployment is at the rate defined by this line, inflation will be stable. However,
in the short-run policymakers will face an inflation-unemployment rate tradeoff
marked by the "Initial Short-Run Phillips Curve" in the graph. Policymakers can
therefore reduce the unemployment rate temporarily, moving from point A to
point B through expansionary policy. However, according to the NAIRU, exploiting
this short-run tradeoff will raise inflation expectations, shifting the short-run curve
rightward to the "New Short-Run Phillips Curve" and moving the point of
equilibrium from B to C. Thus the reduction in unemployment below the "Natural
Rate" will be temporary, and lead only to higher inflation in the long run. The short-
run curve shifts outward due to the attempt to reduce unemployment, the
expansionary policy ultimately worsens the exploitable tradeoff between
unemployment and inflation.
KUZNETS CURVE
A Kuznets curve is the graphical representation of economic inequality increases
over time while a country is developing, and then after a certain average income is
attained, inequality begins to decrease.
Kuznets curve diagrams show an inverted U curve, although variables along the
axes are often mixed and matched, with inequality or on the Y axis and economic
development, time or per capita incomes on the X axis.
The Kuznets ratio is a measurement of the ratio of income going to the highest-
earning households (usually defined by the upper 20%) and the income going to the
lowest-earning households which is commonly measured by either the lowest 20%
or lowest 40% of income. Comparing 20% to 20%, perfect equality is expressed as
1; 20% to 40% changes this value to 0.5.
O KUN’ S LAW
Okun’s law links Friedman’s specification of the Philips curve with the original
Philips curve. It describes the short run between the GNP gap and the
unemployment rate. Okuns law maintains the existence of negative relationship
between the deviation of unemployment rate from the natural rate and the deviation
of actual real income from the potential real income (THE GNP gap).
This law suggest that there is a threshold level of growth even for the maintaining
the current employment rate, which would only become worse if the economy
grows at a rate below if the economy grows at a rate below that minimum level.
FISCAL POLICY
Fiscal policy can be contrasted with the other main type of macroeconomic
policy, monetary policy, which attempts to stabilize the economy by controlling
interest rates and the money supply.
The two main instruments of fiscal policy are
1) Government expenditure, and
2) Taxation.
Changes in the level and composition of taxation and government spending can
impact on the following variables in the economy:
• When the government runs a budget deficit, funds will need to come from
public borrowing (the issue of government bonds), overseas borrowing,
or monetizing the debt.
• Once the currency appreciates, goods originating from that country now cost
more to foreigners than they did before and foreign goods now cost less than
they did before. Consequently, exports decrease and imports increase.
MONETARY POLICY
Monetary policy is exercised by the central policy of the country- the Reserve Bank
of India(RBI)-has instrument like bank rate, cash reserve ratio, open market
operation,statutary liquidity ratio, interest rate, selective credit control.
RBI control repo and reverse repo rate as well but these are basically to manage the
liquidity in the system.
In India we have managed floating exchange rate system, where the exchange rate
is determined basically by the free interplay of the demand for and supply of foreign
exchange.