Inflation & Phillips Curve

Inflation is the persistent rise in the general level of prices of goods and services in an economy over a period of time. It is measured by calculating the percentage change in the Consumer Price Index (CPI) or the Wholesale Price Index (WPI) over a period of time. Inflation has a significant impact on the economy and affects various economic factors, including employment, income distribution, and interest rates.

Types of Inflation:

There are three main types of inflation:

Demand-pull inflation: It occurs when the aggregate demand for goods and services in the economy exceeds the aggregate supply, leading to an increase in the general level of prices.

Cost-push inflation: It occurs when the cost of production of goods and services increases, leading to an increase in the general level of prices.

Structural inflation: It occurs due to structural deficiencies in the economy, such as poor infrastructure, rigid labor markets, and lack of competition, leading to a persistent rise in the general level of prices.

Examples of Inflation:

Let's take a look at a few examples of inflation:

Suppose the price of a gallon of milk is $2 in 2020, and it increases to $2.10 in 2021. The inflation rate for milk in this example is 5%.

If the price of a movie ticket was $10 in 2019 and increased to $12 in 2021, the inflation rate for movie tickets in this example is 20%.

If the price of crude oil was $50 per barrel in 2020 and increased to $60 per barrel in 2021, the inflation rate for crude oil in this example is 20%.

Phillips Curve:

The Phillips Curve is a graphical representation of the inverse relationship between inflation and unemployment. It shows that when unemployment is low, inflation tends to be high, and vice versa. This concept was first introduced by A.W. Phillips in 1958 and has since been used as a tool to understand the dynamics of the labor market and inflation.

Examples of Phillips Curve:

Let's take a look at a few examples of the Phillips Curve:

Suppose an economy has an unemployment rate of 5% and an inflation rate of 2%. If the economy experiences a decrease in unemployment, say to 4%, the Phillips Curve suggests that inflation will increase to a certain extent, say to 3%.

In another scenario, if the unemployment rate in an economy is high, say 8%, the Phillips Curve suggests that the inflation rate will be low, say 1%. However, if the economy experiences a decrease in unemployment, say to 6%, the Phillips Curve suggests that the inflation rate will increase, say to 2%.

Suppose the central bank in an economy decides to pursue a policy of low unemployment, say 4%, and has to tolerate higher inflation, say 3%. The Phillips Curve suggests that as the economy moves towards lower unemployment, inflation will increase.

References:

Blanchard, O. (2017). Macroeconomics. Pearson Education.

Dornbusch, R., Fischer, S., & Startz, R. (2018). Macroeconomics. McGraw-Hill Education.