(#205) The Phillips Curve

The relationship between inflation and unemployment

A component of Welker's Wikinomics Video Lecture Series posted on 1/10/12 and 1/11/12, respectively.

 

This video lesson introduces a basic Macroeconomic model showing the short-run tradeoff that exists between inflation and unemployment in nation's economy. By examining the effect that a shift in Aggregate Demand has on the average price level and the level of output and employment, we observe a simple tradeoff: lower unemployment generally comes at the cost of higher inflation, while lower inflation may require higher unemployment.

In the second lesson on the Phillips Curve model we will further explore the relationship between unemployment and inflation in an economy, this time examining what happens in the long-run, or the flexible-wage period, following a change in aggregate demand in an economy. Will the tradeoff between inflation and unemployment exist even once wages and prices have had time to adjust to the level of demand for a nation's output?

We will find that, in fact, as an economy self-corrects from changes to aggregate demand and output returns to its full employment level, the unemployment rate will always return to its natural rate, even as inflation rises and falls with demand in the economy.

What is important to note is that the author prefaces changes in his model resulting from changes in the economy with statements that are essentially saying "assuming no government intervention".  In other words, the point that is being made is that, assuming the government does not intervene in the economy, the free market is self-correcting.