MACROECONOMICS – II | III UG

UNIT 4 : INFLATION

DEPARTMENT OF ECONOMICS
STELLA MARIS COLLEGE (AUTONOMOUS), CHENNAI

Ms. SUDHARSHINI MURALI| DECEMBER 2021

INTRODUCTION

• UNIT 4.1 (SELF-STUDY)

• DEFINITIONS
• TYPES OF INFLATION
• CHARACTERISTICS/FEATURES OF INFLATION
• CAUSES OF INFLATION – DD SIDE & SS SIDE
• EFFECTS

• REFER INTRO PPT, NOTES FROM TEXTS & NOTES 2 – GOOGLE

CLASSROOM DRIVE
UNIT 4.2. THEORIES OF INFLATION

• EXCESS DEMAND OR DEMAND PULL INFLATION THEORIES

• CLASSICAL THEORY
• EXCESS DEMAND ANALYSIS
• INFLATIONARY GAP ANALYSIS
• BENT – HANSEN’S DEMAND INFLATION THEORY

• COST INFLATION OR COST-PUSH INFLATION THEORIES

• WAGE PUSH
• MARK-UP PRICING
• PROFIT PUSH
 EXCESS DD OR DD PULL INFLATION THEORIES
• CLASSICAL THEORY: Traditional quantity theory
• Excess DD or DD pull inflation → Too much money chasing too few goods.
• Changes in price level → changes in qty of money : Assumes proportionate relationship b/w M & P. ( If
change in qty of money is 10%, prices also change by 10%)
• Knut Wicksell: New money flows into economy – bank advances to businessmen for financing investment in
excess of current rate of saving. ↑ in agg. DD (considering economy at full employment so fixed ss of
goods) → ↑ in prices → Increased consumer purchases → competitive buying → further rise in prices.
• Theory crumbled in 1930s – steep fall is velocity of money circulation (V) which was assumed constant. Money ss →
main sole determinant of prices in full employment in long run.
• Criticism: Failed to relate a rise in M to increase in spending by people → no logical explanation about
how prices are bid up when stock of money is raised, at a given constant level of o/p.
• Warburton: ∆ in M ➔ ∆ in V

Influence price level directly by ∆ in income & spending → ∂M →∂Y →∂P

QTY OF MONEY
Influence price level indirectly by ∆ in velocity → ∂P →∂V →∂Y → ∂P
EXCESS DEMAND ANALYSIS:-
• Rising prices → started and continued by conditions of excess DD for goods and
services > ss of goods and services.
• Pure excess DD inflation can be depicted as: Where Y axis- Real Income (Y) & X
axis- Price level (P).
• The downward sloping linear curves depict agg. DD → Downward sloping due to
the real balance effect.
• Real Balance Effect → denotes the influence of changes in the real stock of
money on consumption expenditure ➔ a change in consumption expenditure
as a result of changes in the real value of the stock of money in circulation. This
theory assumes money neutrality & static price expectations.
• Agg SS function moves upwards from left to right and becomes vertical
(perpendicular to the X axis) when economy hits full employment.
• At D0, given full employment level of real o/p , price is P0. As agg. DD functions
shifts up, with agg. SS remaining constant, price level shifts from P0 to P1, and
then to P2.
• Excess DD can be analyzed in terms of IS and LM functions. A ↑ in C, I or Govt.
Spending can shift the IS function upwards → Excess DD over full emp. o/p or Y
→ Increased transactions requirement due to higher prices → divert to
transaction balances from passive balances → ↓ in LM function.
• General eqm will be achieved at full emp Y level where price and interest rate
are higher than what they were originally. This is depicted as: Where IS0 shows
the investment-saving function and liquidity preference ss of money curve is
LM0, Eqm Y at full emp is Y0 and rate of interest is r0. When Govt. exp. ↑ (liberal
C or I spending) → IS shift to IS1 → Y increases to Y1 from Y0 → Prices shoot up
→ real supply of money falls → LM shifts to the left to LMP1 → General eqm is
restored at intersection of IS1 and LMP1 at full emp Y level Y0, however price and
rate of interest are higher at P1 and r1 respectively.
 THE INFLATIONARY GAP ANALYSIS

• Keynes- Departure from traditional analysis- explanation of war time inflationary situation | Flow of national exp.- main determinant of price
level.
• Given full emp. o/p - ↑ exp. → inflationary gap widens → ↑ prices.
• Kurihara: “The excess of anticipated expenditure over the available output at base prices or at the pre-inflation prices.”
• Keynes- War time rise in Govt. exp.→ inflationary gap. The gap analysis can be done if there is ↑ in investment exp or a ↑ in consumption
spending.
• Inflationary gap – excess of expected exp over available ss of o/p . Expenditure – determined by current income & expectations of future
income. SS of o/p – conditioned by level of employment & state of technology. Flow of real o/p – fixed at full emp. – expectation of ( flow of
expenditure > o/p) → Price rise → widens gap → inflations gains momentum. If tax & savings measures adopted – can do away with the gap.

This figure depicts the inflationary gap. X axis –Flows of income

& Y axis- flows of exp. ( C,I,G). Both income & exp. Are
measured in real terms. (money terms after full employment)
o The agg. Expenditure curve – intersects 45o line at E0 – eqm Y level is Y0, taken to be full emp.
income. Full emp o/p is E0Y0.
o If agg. Exp. ↑ → curve shifts higher -> cuts 45o line at E1 – eqm Y is Y1 – o/p is E1Y1.
o NOTE: Full emp. Productive capacity is fixed at E0Y0 or E2Y1 so agg. Exp. E1Y1 > ss of o/p E2Y1 by
E1E2 → Inflationary gap → Multiplier times the excess of expenditure over o/p at Y0. This gap
bids prices up → anticipated exp will ↑ → inflationary pressures build.
NOTE : This model holds water only when the economy is operating at full employment level. In
under-full employment → excess agg DD → some ↑ in o/p → reduce inflationary gap and pull
down rising prices.
o PROBLEM POINTS : If income and exp are in real terms – no such thing at eqm price level ➔
inflation continues indefinitely as long as gap exists.
o If income and exp. Are measured in money terms – stability of agg exp function is highly
questionable – unless inflation is short & small.

o FACTORS AFFECTING INFLATIONARY GAP: Some affect speed of inflation, others strengthen the
inflation process, while others weaken it.
1. Rate of ↑ of money stock : ↑ in money stock in same proportion to an ↑ in price level or in
greater proportion → expansion of C or I spending → widen inflationary gap. However, if stock of
money remains constant or ↑ in smaller proportion than prices → rate of interest ↑ → fall in agg.
DD for goods & services → inflationary process gets checked. Monetary factor will have
dampening effect when : 1. Income-elasticity of transactions DD for money is high ; 2. Interest-
elasticity of the DD for money is low ; 3. Interest-elasticity of marginal efficiency of investment is
low.
2. Income redistribution : Inflation → redistributes real Y against fixed Y groups. Marginal Prop. To
spend is higher – agg C function shifts down. If Y is redistributed to those with high MPC – agg C
function increases → inflation ↑.
3. Pigou Effect : Inflations → reduces real value of cash balances. To the extent that Pigou effect is
present → C spending will fall → Inflation curtailed.
4. Nature of expectations : Expectations towards rising prices → accelerated/checks inflation
If price rise is expected → purchase of consumer goods, inventories and fixed capital will be accelerated → gather
requirements before price rise. Expectations towards temporary rise and then falling prices → purchases will be
postponed → eventually reduce inflationary gap →rise in prices will be dampened.

5. Lag b/w expenditure & income: Emphasis on lag in adjustment of exp to increasing incomes. If people want to hurriedly
spend incomes as soon as they receive it to avoid hit to purchasing power → Inflationary gap widens & inflation is
accelerated. If average lag b/w income & spending is long → inflation will be slow.

6. Rate of interest: When monetary authority → more money ss → lowers rate of interest → Inflation gains impetus →
Increase I, C & G spending → widens inflation gap. Initial impetus can come even through an autonomous upward shift in
C, I or G Exp. Functions.

7. Adjustment of wages to prices: Rapidity of wage adjustment → Impacts speed & strength of Inflation. If adjustment is
incomplete → profits rise relative to wages. MPC out of wage Y > MPC out of profits →C spending falls. Propensity to
spend on investment is high for profit Y → Rise in investment. Thus, net effect of incomplete adjustment is difficult to
gauge.

8. Rate of change of tax collections: If tax collection ↑ faster than prices (in a progressive tax system) → C function will
shift downwards → reduced inflationary pressure.

9. Changes in foreign trade: Inflation – affects foreign trade of a country → Rising prices internally →discourage exports &
encourages imports → Payment deficits | Drain of gold or Forex reserves → Can also relieve inflationary strains by ↑ ss of
goods (as a result of ↑ imports & ↓ exports)
 BENT HANSEN’S DEMAND INFLATION THEORY

• Post-war theory – 1951 – Criticised Keynes’ inflation analysis → wage rates tied to prices or autonomously determined – not
realistic ➔ confusion b/w cost inflation and demand inflation | Misdirected criticism
• Hansen – wage rates in a pure model of DD inflation to be determined by SS of & DD for labour.
• Keynes: considers excess DD in the goods market | Hansen: Inflationary pressures - even from services (factors) market
• Hansen’s theory → towards disaggregation → Goods markets ≠ Factor/services market
• Applicability of Hansen’s theory : Suppressed inflation | Structural unemployment & unemployment inflation

Excess DD for goods – GOODS GAP

Inflationary
Hansen
circumstances
Excess DD factors (mainly L)

• For full inflation – positive excess DD for goods & factors – goods gap as well as factor gap
• X axis – Reciprocal of real wage rate (P/W) | Y axis – real income (Yr)
• D – Agg. DD curve which is downward sloping due to MPS of wage-earners > MPS of
profit-receivers.
• Thus, total L income varies directly with the real-wage rate.
• S – Agg. o/p of firms at each price-wage ratio for unlimited L ss → upward sloping
(WHY?) - Real wage rate falls → workers at higher real wages enjoy leisure & more
goods → S1 first rises and then bends backward → Indicates that L ss sets a threshold
upon economic capacity to produce at full emp.
• D-S1 : Goods Gap – Responsible for ↑ in price level| S-S1 : Factor Gap – Responsible for ↑
in money wages - Both these gaps are +ve b/w (P/W)4 and (P/W)2. At (P/W)4 and (P/W)2
points – one gap will be +ve and other will be 0.
• The time rates of the change in price level and wages are given by these conditions :
(given by Samuelson)
𝑑𝑝
• = f1 (D-S1)
𝑑𝑡
𝑑𝑤
• = f2 (S- S1)
𝑑𝑡

• At (P/W)2 - Goods gap =0 , Factor gap – Large → Money wages rise rapidly however, no
change in price level → The real wage rate rises and P/W declines → Factor gap is
reduced → But goods gap widens
• At (P/W)1 – Goods gap < Factor gap → Here, due to a rapid rise in money wages and
slower rise in price level → real wage will tend to rise.
• When P/W falls below (P/W)0 → Goods gap > Factor gap → Rapid rise in price level but
slower rise in money wages → Real wage rate falls → This condition exists at both
(P/W)4 and (P/W)3
• The real wage rates will thus fluctuate b/w (P/W)2 and (P/W)4.
• The actual speed of inflation → depends on absolute sensitivity of wages and price
changes relevant to size of gaps ➔ Both gaps volatile – Rapid Inflation | Both gaps
slower – Slower Inflation.
 COST INFLATION OR COST-PUSH INFLATION
THEORIES
Cost or SS theories of inflation → attributed to inflation due to push of wages, mark-up pricing policies and profit push.
WAGE PUSH:-
- Cost inflation – contrast to DD pull inflation → Main cause of rising prices – on SS side
- Recall: Initial stage - Autonomous ↑ in DD (given full employment capacity) → ↑ in prices → Excess DD conditions cause prices to
shoot up more.
- Here, money wages too ↑ - Consequence of inflation but not a cause for it.
- However, cost push inflation theories reverse the causal sequence. Here – Initial stage – Autonomous ↑ in money wages or price of other
inputs → Producers will try to defend themselves → ↑ prices of final G & S to cover rising costs → Prices ↑ but real wages get eroded.
Workers – want to keep the wage they take home unharmed → want to neutralise prices by an ↑ in wages → HOW will they do this? →
Action by trade unions → ↑ money wages ➔ ↑ prices → INFLATION → continues with push of wages & costs (domino effect on price
level when no excess DD is there)
- Here, strong role to trade unions is assumed → Emphasise on compensatory ↑ in money wages (when prices are ↑) to avoid hit on
workers’ take home real wages. Nevertheless, money wage ↑ is not merely through trade unions.
- Labour contracts may have clauses that ask for wage rates to be ↑ with an ↑ in cost of living index.
- Money wages will ↑ even with increased productivity of labour → This might not cause inflation to occur.
- ↑ in production → some moderating effect on prices.
- ↑ in money wages could be due to : scarcity of labour services | competition among
employers | motive to preserve industrial peace | to justify actions concerning product price
increases (in case of monopolistic markets and oligopoly) | to maintain wage parities in
various industries |
- Initial impetus for price ↑ could come from ↑ in cost of imported inputs → cost of inputs ↑
leads to ↑ in price of final goods → ↑ in money wages → bid up prices further →
INFLATIONARY CONDITIONS

MONEY WAGES : WAGES PAID FOR THE WORK PERFORMED,

WITHOUT TAKING INTO CONSIDERATION THE AMOUNT OF GOODS
& SERVICES THAT CAN BE BOUGHT WITH IT.

REAL WAGES : WAGES ADJUSTED FOR INFLATION, MEASURED

TAKING INTO CONSIDERATION THE AMOUNT OF GOODS & SERVICES
THAT CAN BE BOUGHT WITH IT.
MARK-UP PRICING
Mark up refers to the value that a player adds to the cost price of a product. The mark-
up added to the cost price usually equals retail price. The amount of markup allowed
to the retailer determines the money he makes from selling every unit of the product.

• Inflationary potential of cost-push inflation → also determined by mark-up pricing.

• Gardner Ackley : “Inflation might start from the initial autonomous increase in business & labour
mark-ups.”
• Other economists also analysed inflation w.r.t. mark-up policies.
• Business firms → fix selling prices of products → take into consideration the direct costs per unit of
output (wages & raw materials) → add these to a conventional % ‘mark-up’ to cover overheads →
ensure profit margin
• Direct cost : Cost that can be directly tied to the production of specific goods or services.
• If prices are cost-determined → mark-up will be raised when there is fear of rising costs that will in
turn erode profit margin.
• Compensatory ↑ in prices → reduce real wages → ↑ in money wages → Push costs →firms will ↑
prices of final products further → Inflation persists.
• But why does mark-up pricing facilitate a cost-push?
 Prices ↑directly faster
than money wages
REASONS FOR MARK-UP
PRICING TO FACILITATE
COST-PUSH When there is mark-up
pricing, the resistance by
management towards
wage increase will be
lesser.

• If DD is ↓, mark-up sets rigid wages into the price floor.

• If there is profit maximisation & flexible prices → ↓ in DD → ↓ in prices → ↓ in profit margins →
Employers will resist maintenance of previous wage levels.
• If DD is ↑ fast, if there is a DD pull as against a cost-push → mark-up pricing may slow down ↑ in prices.
Since ↑ in prices – not determined by costs ; demand increases at a higher rate than cost → prices will be
marked at lower levels than warranted by DD.
• Thus, mark-ups adjust with time to DD conditions → influence price rise.
• Mark-up inflation can be checked → restrict DD through monetary & fiscal measures | ↑ productivity |
Adopting income policy.
PROFIT PUSH
• ↑ in profits → ↑ in prices.
• If administered prices exist → business firms may ↑ prices without any ↑in DD of costs.
• Effect of profit-push on prices < effect of wage-push
• WHY? 1. Profits make up a smaller portion of price than wages | 2. Profit-push – One time , wage-push –
continuous
• Employee organisations – constant effort to get higher wages – when there is fear of fall in real wages
→ immediate claims for higher wages.
• Profits of firm – not dependant solely on high prices → also depends on larger sales and lower unit
costs. Wage-wage spiral may exist too.
• Profit competition among firms – low. If competition to ↑ profits exists → carried out by ↑ in
productivity or ↑ in sales by ads, etc. and not through competitive price ↑.
• Effect of wage ↑ on Agg. Exp > Effect of profit ↑ on Agg. Exp.
• Thus, profit push → ↑ in prices but impact lesser than that of wages & costs.
• Cost inflation caused by push of costs, wages or
profits is depicted here. D is the agg. DD function and
SS0 is the agg. SS function which initially slopes
upwards and then becomes perfectly inelastic at full
employment level of income or output Y0.
• Assuming there is eqm at full employment → price P0
is determined by intersection b/w SS0 & D.
• If agg. supply function shifts → S1 → This shift caused
by : 1. Workers secure more wages | 2. Higher prices
charged by monopolistic or oligopolistic industries.
• As shift to S1 happens → eqm is at determined at Y1
level of income – less than full employment income
and o/p – and prices P1.
• When shift to S2 happens → eqm income falls further
to Y2 → however, prices will rise to P2. Thus, in pure
cost-push inflation → prices rise but employment
falls. That is price rise is accompanied by rising
unemployment → Unemployment – cost of holding
prices close to P0.
• If Govt. wants to maintain full employment level →
Price level shall ↑ much more.
• Cost-push inflation can be explained w.r.t. IS- LM curves as well.
• System in gen eqm at Y0 full emp income . → Rate of interest r0
→ price is P0.
• Autonomous rise in wages or costs pushes prices up → LM
function shifts to LMP1. The system is now in eqm → at Y1 less
than full emp income → Unemployment exists and is depicted by
the gap Y0Y1.
• If Govt. wants to maintain full emp level → in turn brings about
a shift is IS from IS0 to IS1 → eqm achieved at Y0 income.
• Price has risen from P0 to P1 → Interest rate has risen from r0 to
r1.
• Wage-cost-price spiral – deepens inflation more.
• Push of wages → initiates prices to shoot up but timing of the
inflationary process will vary with each industry → this will
depend on relative strength of trade unions, employer resistance
to employee –claims, speed at which firms increase price of
finished goods.
• Domino effect could be felt between industries and occupations
→ depends on reactions of price rise in one industry and its
impact on costs and prices of other industries | efforts of trade
unions to maintain wage differentials between their own
members’ earnings & those in other occupations.
 STAGFLATION
• In early 1970’s → Many countries experienced inflation and declining o/p, employment and under-utilisation of
productive capacities at the same time→ Paradox → Inflation + Stagnation → STAGFLATION
• Example : Soviet Scissors Crisis (1920) - Like the blades of a pair of open scissors, the prices of industrial and
agricultural goods diverged, reaching a peak in October 1923 where industrial prices were 276 percent of their 1913
levels, while agricultural prices were only 89 percent. This meant that peasants' incomes fell, and it became difficult
for them to buy manufactured goods. As a result, peasants began to stop selling their produce and revert to subsistence
farming, leading to fears of a famine.
• Before 1971 – Govts – due to political pressures – expansionary MON.POL & FIS. POL. → Expansion of o/p → Rise in
prices.
• Predominance of cost-push elements of inflation → rise in unemployment.
• Abandonment of fixed exchange rates in 1973 → More trade barriers & the restrictive monetary & fiscal policies →
uncertainty & chaos.
• In 1974 & 1975 – new mixture of inflation and slump in Western Europe, Japan and other nations (Indian stagflation –
1973-75) – Inflation on one side, shortfall in production of agro raw materials, on the other side. Engineering and
capital goods industries had to contend with the slump → under-utilization of existing capacity.
• Indian economy eventually improved – but, back to stagflation in 1978-79 → Expansion in agriculture coupled with fall
in industrial growth.
• Rate of industrial growth had fallen nearly to 0 → indicating stagflation.
• Strain of supply-side shocks → leading to unemployment & inflation co-existing.
• Acc. To Bruno & Sachs , stagflation in 1970s & 1980s was because of: 1. large &
unanticipated increases in relative prices of raw materials like oil, etc. 2.
Downward rigidity of real wages measured in terms of consumption prices.

• As price increase of imported inputs and wage rates tend to shift the agg. SS
function to the left, prices increase and so does unemployment.
• Control of stagflation : Keynesian economics – Depression economics – all tools
formulated were to deal with depression, stagnation & unemployment in
advanced countries. If we follow Keynesian recommendations like progressive
taxing, increasing public expenditure , deficit financing and cheap money
policies, etc. → Aggravate inflation and deepen unemployment more when
stagflation is already prevailing. MON POL & FIS POL → not effective in
curtailing stagflation.

• Employment N is on X axis. Price P is on Y axis.

• D0 – initial agg. DD function & S0 – initial agg. SS function.
• Eqm E0 → Emp is N0 & Price is P0.
• If raw material prices and other input prices rises → Agg. SS function shifts to
S1. Eqm is now at E1 where emp falls to N1 and prices rises to P1 →
STAGFLATION.
• If restrictive MON and FIS policies are taken → Agg. DD shifts to D1
• D1 & S1 intersect at E2 where economy is at initial price level P0 but
unemployment gap widens to N0N2.
• If expansionary policies are taken → Agg. DD shifts to D2 – Eqm is at E3 where
there is full emp N0 but prices rise much more to P2. Thus MON AND FIS POL –
not effective in the case of stagflation.
• Need for a proper blend of credit control measures, differential interest rates,
reduction in personal and business taxes, easy availability of industrial inputs
and dynamic export policy, etc.
CONTROL OF INFLATION
• CONTROL OF EXCESS DD INFLATION – Caused by an ↑ in agg. DD in goods & services
over & above the full employment level of real output → Measures to control this kind of
inflation → directed towards a fall in agg spending by the community. These measures are:
• MONETARY MEASURES
• FISCAL MEASURES
• DIRECT CONTROLS
• MONETARY MEASURES : Excessive spending by the community during war & peace →
associated with tendencies of monetary authority to ↑ SS of money. Central bank of a
country can regulate the economic activity by influencing availability & cost of credit → Can
employ these instruments:
• Open market sale of securities
• Increase in bank rate
• Increase in Statutory reserve requirements
• Higher structure of interest rates on deposits & advances
PHILLIPS’ CURVE
• A.k.a – Inflation Unemployment Trade-off – Developed by A.W. Phillips
• Phillips analysed data on unemployment % & wage % in Britain between 1861-1957.
• Aim of the analysis – 1. To see if Demand pull or Cost push inflation impact was strong in Britain. 2. To find out the extent to
which restrictive MON. & FIS. POL could help curb inflation. (In DD inflation – Monetary & Fiscal restraints help in checking on
the expansion of agg. DD. However, these become ineffective for SS inflation.) When there is SS inflation → Restrictive MON
& FIS POL will aggravate inflation by restraining the excess DD level (thereby restraining investment spending) → Slows down
the rise in labour productivity. This labour productivity could have otherwise off-set the wage push effect.
• MON & FIS POL – likely to curb wage-push inflation by creating massive unemployment → Prevents the rise in money wages
above and beyond the rise in labour productivity → price stability in the society – at the cost of allowing for some
unemployment to exist at amounts that are not acceptable to society. Suppose, in order to maintain price stability, high
levels of unemployment are needed – then, society will choose the lesser of the two evils, that is, go for the choice with has
a smaller adverse impact. Therefore, accept moderate inflation that is accompanied by an acceptable level of
unemployment.
• PHILLIPS’ CURVE - tries to understand and analyse how much reduction in employment would be needed to stop or
completely curb inflationary effects.
• Phillips : Wage rates rise rapidly when employment was low | Wage rates fell when employment was high | Wage rates
remained unchanged when approx. 5.5 % of the labour force was out of the job → Thus, relationship between rate of change
of wage rates – inverse & non-linear – WHY? Reasons follow:
• RELATIVE BARGAINING STRENGTH OF TRADE UNIONS & MGT.
• GENERALISED EXCESS DD FOR LABOUR
• IMBALANCES BETWEEN SS & DD IN LABOUR MARKET
- RELATIVE BARGAINING STRENGTH OF TRADE UNIONS & MGT – When
unemployment rates & business activity undergo changes, the
bargaining strength also varies – With low unemployment rates → TU
appeals for large hike in money wages. During large unemployment →
wage claims are not aggressively made.
- GENERALISED EXCESS DEMAND FOR LABOUR – Wage increases are not
always brought about by union action. In many places, a very small
proportion of labour force is unionised. Nevertheless, there in inverse
relationship between wages & unemployment due to general excess DD
for labour.
- IMBALANCES BETWEEN SS & DD IN LABOUR MARKET - If in some labour
markets there are issues related to switching careers (occupational
mobility) & switching locations (geographical mobility). Labour
shortages in one sector → Push up wages even during unemployment
periods → as workers from one sector have difficulties in shifting to
sectors where DD for labour > SS of labour.
- Phillips – plotted the % changes in wage rates & unemployment on a
scatter diagram → best fit given by the red non-linear curve.
- It depicted how number of vacancies > number of job seekers, when
unemployment percentage was below 5.5 %. Excess DD for labour →
wages rise. When unemployment % was more than 5.5 % → excess SS in
labour market brought down wage rates. The shape of the curve → DD
pull was stronger than cost-push during the period covered by Phillips.
- A general fall in unemployment rate – firms will see it as a hint towards rising demand for labour → more
labour hired as higher wages are anticipated.
- By using this curve – Phillips’ determined a rate 5.5% unemployment in UK is required for maintaining a steady
pace of wages. A rate of 2.5 % unemployment is required if prices are to be steady → Indicates that wage rise
would be in the same percentage as the rise in productivity (approx. 2 % per annum)
- JA Pechman – Phillips’ suggestion about correlation between changes in wages and unemployment for Britain –
exaggerated view | Samuelson & Solow’s findings → have not been empirically supported
- WIDENING THE SCOPE OF THE PHILLIPS’ CURVE:
- Lipsey– reworked Phillips’ data – over 4/5ths of variance of money wages could be associated with level of
unemployment and its rate of change.
- He said that the relationship between wages & unemployment – weaker after 1913
- Wage changes – related to changes in cost of living index during inter-war & post-war periods.
- Routh – objected to Phillips’ data aggregation methods
- Kaldor – Hypothesised change in wage rates in UK depending upon profit levels.
- Dicks Mireaux & Dow – Britain – V (Unfilled Vacancies) & U (Unemployed job seekers) Gap → 1 % rise in V-
U Gap associated with a 3-4 % rise in wages.
- Many others criticised the Phillips’ curve.