The Phillips curve expresses the short-run trade-off between
A. inflation and deflation.
B. inflation and recession.
C. inflation and unemployment.
D. unemployment and deflation.
The correct answer and explanation is:
The correct answer is C. inflation and unemployment.
The Phillips curve is an economic concept that illustrates an inverse relationship between inflation and unemployment in the short run. This relationship suggests that as unemployment decreases, inflation tends to increase, and vice versa. The curve was first introduced by economist A. W. Phillips in 1958 after observing that during periods of low unemployment, wages tend to rise, which in turn leads to higher costs for businesses. These higher costs are often passed on to consumers in the form of higher prices, contributing to inflation.
The logic behind the Phillips curve is based on the idea that when the labor market is tight (unemployment is low), workers can demand higher wages because employers compete for a smaller pool of available workers. Higher wages lead to increased consumer spending, which drives demand for goods and services, pushing up prices. This creates inflationary pressures. On the other hand, when unemployment is high, workers have less bargaining power, wage growth slows, and inflation tends to fall.
However, this relationship does not hold in the long run. Over time, expectations adjust, and if inflation continues to rise, workers and businesses start to expect higher prices, which can lead to a return of inflation even at higher levels of unemployment. This phenomenon is known as the long-run Phillips curve, which is vertical, indicating that there is no trade-off between inflation and unemployment in the long run.
The short-run trade-off between inflation and unemployment is important for policymakers because it helps them understand how monetary and fiscal policies can influence these two variables. In practice, managing inflation while minimizing unemployment remains a key challenge for central banks and governments.