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The Phillips Curve Unemployment • Number of people willing and able to work but don’t have work • Calculated as a percentage of the working population • Method of Measurement Government statistics on the number of people getting unemployment benefits Inflation • A sustained increase in the general price level (average price of goods and services) • Calculated as a percentage increase per year • Method of Measurement – Creation of a basket of goods and services bought by an average household – Calculate total expenditure on the basket – Calculate increase in expenditure on the same basket over years using a Weighted Price Index – Rate of Inflation = Percentage increase in the WPI Phillips Curve • Proposed by economist AWH Phillips (1914 – 1975) • Theorized the Inverse (indirect) relationship between Inflation and Unemployment High Unemployment Low Unemployment Low Wage Raises Low Spending on Goods Low Increase in Prices of Goods ( Low Rate of Inflation ) High Wage Raises High Spending on Goods High Increase in Price of Goods ( High Rate of Inflation ) • Data from late 19th to early 20th Century supported the theory • Trade off between Inflation and Unemployment • Useful for Government Policies aimed at controlling either Inflation or Unemployment Milton Friedmen & Edmund Phelps Low Unemployment Expect Higher Inflation Demand Higher Wage Raises Increasing Layoffs Increasing Unemployment • Data from late 1960 - 1980 supported the theory •Oil Price Rises Increased Inflation in the 1970s • C • No Trade off between Inflation and Unemployment • Original Relationship no longer holds Questions • Who was right? Phillips or Friedmand and Phelps? • Which theory is used in Economics? • How is the method of formulation of hypothesis and theories in Economics different from Natural Sciences? • Is experimentation possible in Economics?