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1. The Fed
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PHILIPS CURVE
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Economics data analysis question: The Phillips Curve (a)(i) The Phillips curve is the line which shows that higher rates of unemployment are associated with lower rates of change of money wage rates and therefore inflation and vice versa. The main principle of a Phillips Curve is that it shows an inverse relationship between inflation and unemployment. An increase in inflation would by this theory result to a decrease in unemployment. This theory argues that you can’t have both unemployment and inflation increasing/decreasing at the same time. (ii) Inflation is caused by an increase in aggregate demand. Inflation is a general rise in prices. When more is demanded prices rise. When demand increases output increases as well. To produce this higher level of output more workers are needed and thus unemployment decreases. This diagram illustrates how the relationship between inflation and unemployment works. The cause of inflation, demand, increases from D1 to D2 causing the price level to increase from EP1 to EP2 and quantity supplied/demanded to increase from EQ1 to EQ2. The rise in prices represents the increase in inflation. The increase in quantity supplied demonstrates the decrease in unemployment. (iii) The data from the European Union does support the relationship made by the Phillips curve but the data from the United States doesn’t. First of all the graph of the European Union shows a dramatic rise of inflation in the years 1967 to 1975. From here on a line of best fit can be drawn to see that the relationship here actually does exist though there are inconsistencies of course. A high rate of inflation (14%) with a relatively low rate of unemployment (4%) in the year 1975, and a low rate of inflation (3%) with a relatively high rate of unemployment (12%) shows this trend. The sudden increase in inflation in 1967 might have been caused by extreme circumstances such as large increases in the money supply thus an increase in demand.
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