NATIONAL UNIVERSITY OF

STUDY AND REASRCH IN LAW,

RANCHI

ECONOMICS PROJECT

THE ROLE OF UNEMPLOYMENT AND INFLATION IN SHORT

AND LONG RUN

SUBMITTED TO: SUBMITTED BY:

DR SHWETA MOHAN NAME: MOHD FAHAD ANSARI
ASSISTANT PROFESSOR SEMESTER: 1
SECTION: A
ROLL NO: 1241
 TABLE OF CONTENTS

DECLARATION………………………………………………………………………………….3
ACKNOWLEDGEMENT………………………………………………………………...…...….4
THE CURVE OF PHILLIPS……………………………………………………………………...5
HISTORY ….…………………………………………………………………………………….6
NATURAL RATE HYPOTHESIS……………………………………………………………….8
THE SHORT RUN PHILIPS CURVE………………………………………………………......9
HISTORICAL
APPLICATION………………………………………………………………….10
SHIFTING THE PHILLIPS CURVE……………………………………………………………11
DISINFLATION…………………………………………………………………………………12
 DECLARATION

I, Mohammad Fahad Ansari, a first – semester B.A.L.L.B. student of National University of

Study and Research in Law Ranchi (NUSRL Ranchi), at this moment declare that the project
titled “Trade and Its Implications” under the guidance of Dr. Shweta Mohan ma’am, faculty of
Economics is an original work. I have made sincere efforts in order to complete this project and
have not misrepresented facts or data.
I declare that the statements made and the conclusion drawn are the bona fide outcome of the
research work done by me. I further assert that, to the best of my knowledge and belief, proper
references have been given and do not contain any work that has been submitted to any
university.
 ACKNOWLEDGEMENT
Firstly, I would like to thank my teacher and mentor, Dr. Shweta Mohan ma’am, who showed
faith in me by providing such an excellent topic. Her constant guidance has played a vital role in
the completion of this project successfully. I express my gratitude to all the staff members and
administration of NUSRL Ranchi, for providing me such a beautiful library. Their support
cannot be expressed in words.
Finally, I would like to express my heartfelt gratitude to all those who helped me to complete this
project without any problems.

Thanking you

NAME: MOHAMMAD FAHAD ANSARI

SEMESTER: 1
SECTION: A
ROLL NUMBER: 1241
 THE CURVE OF PHILLIPS
The Phillips curve depicts the inverse relationship between unemployment and inflation: as
unemployment falls, inflation rises. The Phillips curve is a relationship between inflation and
unemployment. According to the Phillips curve, unemployment and inflation are inversely
related: as unemployment falls, inflation rises. However, the relationship is not linear. When the
unemployment rate is on the x-axis and the inflation rate is on the y-axis, the short-run Phillips
curve follows an L-shape graphically.

The theoretical Phillips curve depicts the inverse relationship between inflation and
unemployment. As one grows, the other must shrink. In this illustration, an economy can either
have 3 percent unemployment at a cost of 6 percent inflation, or grow unemployment to 5
percent at a cost of 2 percent inflation.
 HISTRORY
In 1958, economist A.W. Phillips proposed the first version of the Phillips curve. Phillips
monitored salary and unemployment fluctuations in Great Britain from 1861 to 1957 in his
original study, and discovered a steady, inverse link between earnings and unemployment. This
link between salary fluctuations and unemployment appeared to be true in the United Kingdom
and other industrial countries. Paul Samuelson and Robert Solow, two economists, developed
their work in 1960 to include the relationship between inflation and unemployment. Because
wages account for the majority of price fluctuations, inflation (rather than pay changes) may be
inversely related to unemployment.
The Phillips curve idea appeared to be steady and predictable. The trade-off between
unemployment and inflation was reasonably effectively approximated using data from the 1960s.
The Phillips curve predicted possible economic policy outcomes: fiscal and monetary policy
might be employed to promote full employment at the expense of higher prices, or to reduce
inflation at the expense of reduced employment. The Phillips curve, on the other hand, came
apart when governments tried to utilize it to control unemployment and inflation. The data from
the 1970s onward did not follow the conventional Phillips curve trend. For many years, both
inflation and unemployment rates were greater than the Phillips curve expected, resulting in a
phenomenon known as "stagflation." Finally, the Phillips curve was found to be unstable and so
unsuitable for policymaking.
Phillips Curve in the Long Run
Inflation and unemployment are unconnected in the long term because the long-run Phillips
curve is a vertical line at the natural rate of unemployment. The Phillips curve depicts the trade-
off between inflation and unemployment, but how reliable is it over time? In the long run,
economists believe there can be no trade-off between inflation and unemployment. Increases in
inflation can occur when unemployment falls, but only in the short term. In the long run,
unemployment and inflation are unrelated. This means that at the natural rate of unemployment,
or the hypothetical unemployment rate if collective output is at its long-run level, the Phillips
curve is vertical. Attempts to lower unemployment rates simply move the economy up and down
this vertical line.
 NATURAL RATE HYPOTHESIS
Milton Friedman and Edmund Phelps devised the natural rate of unemployment theory, often
known as the non-accelerating inflation rate of unemployment (NAIRU) theory. Expansionary
economic measures, according to NAIRU theory, will only result in transitory reductions in
unemployment as the economy adjusts to its natural rate. Furthermore, when unemployment falls
below the natural rate, inflation picks up. When unemployment is higher than the natural rate,
inflation slows. Inflation is constant or non-accelerating when the unemployment rate is equal to
the natural rate.

AN EXAPMPLE
Consider the example in to obtain a better understanding of the long-run Phillips curve. Assume
the economy begins at point A, with an initial unemployment rate and inflation rate. As
aggregate demand shifts to the right, inflation will rise if the government pursues expansionary
economic policies. This is represented as a movement along the short-run Phillips curve to point
B, an unstable equilibrium. As aggregate demand rises, firms will hire more people to match the
increased need, and unemployment will fall. Workers' expectations of future inflation alter as a
result of increasing inflation, shifting the short-run Phillips curve to the right, from unstable
equilibrium point B to stable equilibrium point C. At point C, unemployment has returned to its
normal rate, but inflation is still greater than it was at the start.
NAIRU and Phillips Curve: Despite the fact that the economy starts with a low level of inflation
at point A, attempts to lower the unemployment rate are unsuccessful, resulting in inflation rising
to point C. Without raising inflation in the long run, the unemployment rate cannot fall below the
natural rate of unemployment, or NAIRU.
The variations in inflation expectations cause the short-run Phillips curve to alter. Workers who
are considered to be totally logical and informed will understand that their nominal earnings have
not kept up with inflation increases (the movement from A to B), resulting in a fall in their real
wages. As a result, they will renegotiate their nominal compensation in the future to reflect the
higher predicted inflation rate in order to maintain their real wages. As nominal wages rise, the
supplier's production costs rise as well, reducing profits. Suppliers will reduce output and hire
fewer staff as profits diminish (the movement from B to C). As a result, a short-term attempt to
reduce unemployment at the expense of higher inflation resulted in higher inflation and no
change in unemployment over time.
When the standard Phillips curve failed to explain the stagflation phenomenon of the 1970s, the
NAIRU theory was utilized. Workers' inflation expectations altered, altering the short-run
Phillips curve and boosting the prevailing rate of inflation in the economy, according to the
hypothesis. Meanwhile, unemployment rates remained unchanged, resulting in high inflation and
unemployment.
 THE SHORT RUN PHILLIP CURVE
The inverse trade-off between inflation and unemployment is depicted by the short-run Phillips
curve. The Phillips curve shows how inflation and unemployment rates are related. In the long
term, the long-run Phillips curve is a vertical line that shows there is no permanent trade-off
between inflation and unemployment. The initial negative relationship between the two variables
is reflected in the short-run Phillips curve, which is essentially L-shaped. When unemployment
rates rise, inflation falls; when unemployment rates fall, inflation rises. Consider the following
example. When the unemployment rate is two percent, the inflation rate is ten percent. As
unemployment falls below 1%, the rate of inflation rises to 15%. When unemployment rises to
6%, however, the inflation rate falls to 2%.

Short-Run Phillips Curve: The short-run Phillips curve depicts a tradeoff between inflation and
unemployment in the short term. Compare this to the long-run Phillips curve (in red), which
indicates that the unemployment rate remains relatively constant over time regardless of
inflation.
 HISTORICAL APPLICATION
The Phillips curve gained popularity in the 1960s because it appeared to correctly reflect real-
world macroeconomics. Stagflation of the 1970s, on the other hand, demolished any illusions
that the Phillips curve was a reliable and predictable policy instrument. Modern economists no
longer believe in a stable Phillips curve, but they do agree that there is a short-run trade-off
between inflation and unemployment. Rises in aggregate demand result in increases in real
production when the aggregate supply curve is stationary. Unemployment lowers as output rises.
More people in the labor means more money in the economy, which leads to demand-pull
inflation, which raises prices. As a result, the short-run Phillips curve depicts a real, inverse link
between inflation and unemployment, but it can only exist in the short run. Economic history has
debunked the assumption of a long-term stable trade-off between inflation and unemployment.
 SHIFTING THE PHILLIP CURVE
The aggregate supply shocks brought on by increased oil prices resulted in both high
unemployment and high inflation. The prevailing school of economic thought at the time claimed
that inflation and unemployment were mutually exclusive, and that high levels of both could not
exist in the same economy. As a result, the Phillips curve was unable to model the situation.
There were now higher levels of inflation than the Phillips curve projected for high levels of
unemployment; the Phillips curve had migrated upwards and to the right. As a result, the Phillips
curve no longer represented a predictable unemployment-inflation trade-off.
 DISINFLATION
Disinflation is a decrease in the rate of inflation caused by changes in the money supply or
business cycle recessions. Inflation is defined as a steady increase in the price of goods and
services. Disinflation is a halt in the rise in price level caused by a decrease in the rate of
inflation. As an example, suppose inflation rises from 2% to 6% in the first year, representing a
four-percentage-point increase. In the second year, inflation rises from 6% to 8%, a two-
percentage-point increase. Because inflation did not rise as swiftly in Year 2 as it did in Year 1,
the economy is experiencing disinflation, although overall prices are still growing. Disinflation
should not be confused with deflation, which is a broad price fall.

CAUSES
Reduces in the amount of money accessible in an economy can produce disinflation. It can also
be induced by business cycle contractions, generally known as recessions. The Phillips curve can
help to clarify this last issue. Consider a country that starts off at point A on the long-run Phillips
curve. Assume that during a recession, the rate at which aggregate demand rises relative to
aggregate supply rises falls. This lowers price levels, reducing supplier earnings. Employers lay
off workers as profits fall, and unemployment grows, moving the economy from point A to point
B on the graph. Firms and workers eventually adjust their inflation expectations, and earnings
return to the industry. As profits rise, so does employment, bringing the unemployment rate back
to its natural level as the economy proceeds from point B to point C. Due to differing inflation
expectations, the predicted rate of inflation has also fallen, resulting in a shift in the short-run
Phillips curve.